Russia: Political and Institutional Determinants of Economic Reforms

Center for Social and Economic Research
CASE Reports
Russia: Political and

Institutional Determinants
of Economic Reforms
Marek Dabrowski, ed. (CASE)

Vladimir Mau (IET)
Konstantin Yanovskiy (IET)
Irina Sinicina (CASE)
Rafal Antczak (CASE)
No. 56/2004
Sergei Zhavoronkov (IET)

Alexei Shapovalov (CASE)
Moscow – Warsaw, March 2004
Electronic copy available at: http://ssrn.com/abstract=1431892

The views and opinions expressed here reflect the author(s) point of view and not necessarily
those of the CASE.
Country Study carried out under the GDN global research project on 'Understanding Reform'.
Key words: economic reforms, transition, Russia, reform sequencing, political reforms,
institutional reforms, political economy.
Review by José María Fanelli, PhD
© CASE – Center for Social and Economic Research, Warsaw 2004
Graphic Design: Agnieszka Natalia Bury
DTP: CeDeWu Sp. z o.o.
ISSN 1506-1647, ISBN: 83-7178-336-1
Publisher:
CASE – Center for Social and Economic Research
12 Sienkiewicza, 00-944 Warsaw, Poland
tel.: (48 22) 622 66 27, 828 61 33, fax: (48 22) 828 60 69
e-mail: CASE@case.com.pl
http://www.case.com.pl

Contents
List of Tables and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1. Introduction ................................................9
2. History of the Soviet/Russian political and economic reforms 1985-2002 . . 14

2.1. The end of the communist 'economic miracle' . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.2. The destabilizing effects of the 'Perestroika' period 1985-1991 . . . . . . . . . . . . . . . 16
2.3. 'Revolutionary' period of reforms, end of 1991-1994. . . . . . . . . . . . . . . . . . . . . . . 18
2.4. The fragile and illusory stabilization of 1995-1998 . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.5. Post-crisis period (1999-2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2.6. The overall record and list of unresolved problems. . . . . . . . . . . . . . . . . . . . . . . . 25
Appendix 2.1. The Main Reform Events and Players, 1990-2003 . . . . . . . . . . . . . . . . . 27
Appendix 2.2. Main institutional changes in Russia, 1985-2003 . . . . . . . . . . . . . . . . . . . 30
The Gorbachev period, 1985-1991. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Period of 'revolutionary' reforms, 1991-1994 . . . . . . . . . . . . . . . . . . . . . . . . . . 30
The period of fragile and illusory stabilization, 1994-1998 . . . . . . . . . . . . . . . . . 30
The post-crisis period, 1999-2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Appendix 2.3. Professional and political debate on economic problems and economic
reforms. Major government economic policy and economic reform programs. . . . . . . 31
3. Political economy of reform – an attempt at a quantitative analysis . . . . . . 32

3.1. The importance of election statistics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
3.2. The basic model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
3.3. The International Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
3.4. The Interregional Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
3.4.1. The significance of the pro-reform coalition . . . . . . . . . . . . . . . . . . . . . . 35
3.4.2. The significance of basic institutions and the pro-reform coalition
for the investment climate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.5. Buying votes and pro-reform coalitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
3.6. Some conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

CASE Reports No. 56 – Russia: Political and Institutional Determinants of Economic Reforms
4. External leveraging of Russia's reforms: the role of the IMF,

the World Bank and the G7 countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
4.1. The overall picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
4.2. Some motivation of lending to Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
4.3. The role of the IMF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
4.4. The role of the World Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
4.5. The role of the G7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
5. The Effects of Economic Reform in Russia . . . . . . . . . . . . . . . . . . . . . . . . . . 53

5.1. Macroeconomic developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
5.2. Structural changes in the economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
5.3. Social indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
5.4. Structural and institutional reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
5.5. Composite development indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
5.5.1. Freedom House indices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
5.5.2. Transparency International Corruption Perceptions Index . . . . . . . . . . . . 67
5.5.3. The Heritage Foundation Index of Economic Freedom . . . . . . . . . . . . . . 68
5.5.4. The Fraser Institute's Economic Freedom of the World (EFW) Index . . . 69
6. Main Hypotheses and Results of Their Testing . . . . . . . . . . . . . . . . . . . . . . . 71

6.1. Hypothesis 1: Domestic crises beget reforms. . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
6.2. Hypothesis 2: External factors shape reform. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
6.2.1. Oil prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
6.2.2. International financial markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
6.2.3. Foreign aid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
6.2.4. The role of international organizations . . . . . . . . . . . . . . . . . . . . . . . . . . 76
6.2.5. The experience of other countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
6.3. Hypothesis 3: Reform success depends on the organization of winners. . . . . . . . . 77
6.4. Hypothesis 4: Sequencing matters virtuous vs. vicious cycle . . . . . . . . . . . . . . . . 79
6.5. Hypothesis 5: Fast reforms are more effective than slow ones . . . . . . . . . . . . . . . 81
6.6. Hypothesis 6: Democratization helps market reforms. . . . . . . . . . . . . . . . . . . . . . 93
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
4
List of Tables and Figures
Table 2.1: Spot crude oil prices, 1972-1998, USD/bbl . . . . . . . . . . . . . . . . . . . . . . . . . 15

Table 3.1: International model: results of a simple regression analysis . . . . . . . . . . . . . 34
Table 3.2. Summary Data on Regressions from the Principal Components . . . . . . . . . . 35
Table 3.3: Interregional model: Summary Data on Simple Linear Regressions. . . . . . . . 36
Table 3.4: Interregional model: Description of variables. . . . . . . . . . . . . . . . . . . . . . . . 37
Table 3.5. Investment climate determinants: results of regression analysis . . . . . . . . . . 38
Table 3.6: Federal transfers and support for Yeltsin in the 1996 elections. . . . . . . . . . . 39
Table 3.7: Federal transfers and support for the government, 1999 compared to 1995 39
Table 4.2: IMF facilities for Russia, 1992-2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Table 4.3: World Bank lending to Russia, 1992-2002 (millions of USD). . . . . . . . . . . . . 48
Table 4.4: The G-7 commitments to Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Table 4.1: Gross financial flows into Russia, 1992-1998 (millions of USD). . . . . . . . . . . 52
Table 4.5: Gross official flows from the G7 into Russia, 1992-1998 (in USD millions
and as a % of total financing). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Table 5.1. FDI in transition countries, 2002 (cumulative, USD M) . . . . . . . . . . . . . . . . 56
Table 5.2. Changes in economic structure (value added, % of GDP) . . . . . . . . . . . . . . 58
Table 5.3. Changes in economy structure (% of total employment). . . . . . . . . . . . . . . 58
Table 5.4. Real incomes of Russian society, 1992-2002, as a % of the previous year. . . 59
Table 5.5. Share of the 'Social Policy' item in total federal budget expenditures, % . . . 60
Table 5.6. Budget expenditures on health care and education, 1992-2000,
as a % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Table 5.7: Transition countries: Gini coefficient of income per capita . . . . . . . . . . . . . . 62
Table 5.8. Coefficients of differentiation and concentration of income, 1991-2000
(total money income = 100) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Table 5.9. Population with money incomes below minimum subsistence level . . . . . . . 63
Table 5.10. Human Development Index Trends 1985-2001 . . . . . . . . . . . . . . . . . . . . . 64
Table 5.11. Privatization results in selected CEE and CIS countries . . . . . . . . . . . . . . . 64
Table 5.12. EBRD indices of structural reform and institution building in Russia . . . . . . 65
Table 5.13. Russia's 'Freedom in the World' Ratings, 1991-2002 . . . . . . . . . . . . . . . . . . 66
Table 5.14. 'Nations in Transit' Scores, 1997-2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Table 5.15. The Corruption Perceptions Index, 1998-2002 . . . . . . . . . . . . . . . . . . . . . 67
Table 5.16. The HF Index of Economic Freedom, 1995-2003 . . . . . . . . . . . . . . . . . . . 68
Table 5.17. EFW Index , 1990-2001. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Table 6.1: What can be done gradually? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
5
Figure 2.1: General Government Budget Balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Figure 4.1: Russia's compliance with IMF quantitative monetary, fiscal,
and exchange rate targets in 1993-1999 (in %) . . . . . . . . . . . . . . . . . . . . . 44
Figure 4.2: IMF net disbursements to Russia in 1992-2001 (millions of USD) . . . . . . . . 45
Figure 5.1. GDP (constant 1995 USD), annual % change. . . . . . . . . . . . . . . . . . . . . . . 54
Figure 5.2. Inflation, consumer prices (annual %) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Figure 5.3. Volume indices of investments in fixed capital in Russia (1990=100). . . . . . 55
Figure 5.4. The CBR's gold and foreign exchange reserves, 1997-2003 (million USD) . 57
Figure 5.5: Money and quasi money (M2) as a % of GDP . . . . . . . . . . . . . . . . . . . . . . 57
Figure 5.6. Total (ILO definition) and registered unemployment in Russia,
as a % of the labor force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Figure 6.1. Oil and Non-oil Fiscal Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Figure 6.2: Support to reformers and financial aid of major donors, 1991-1999 . . . . . . 75
Figure 6.3: Political and economic dynamics of the transition process . . . . . . . . . . . . . 82
6
Contributors
Marek Dabrowski
Professor of Economics, Chairman and one of the founders of the CASE - Center for Social and
Economic Research in Warsaw. From 1991 involved in policy advising for governments and central
banks of Russia, Ukraine, Kyrgyzstan, Kazakhstan, Georgia, Uzbekistan, Mongolia, and Romania;
1989-1990 First Deputy Minister of Finance of Poland; 1991-1993 Member of the Sejm (lower
house of the Polish Parliament); 1991-1996 Chairman of the Council of Ownership Changes, the
advisory body to the Prime Minister of Poland; 1994-1995 visiting consultant of the World Bank,
Policy Research Department; 1998-2004 (February) Member of the Monetary Policy Council of
the National Bank of Poland. Recently his area of research interest is concentrated on
macroeconomic policy problems and political economy of transition. He is an author and co-
author of numerous publications including several books.
Vladimir Mau
Dr. Vladimir A. Mau is a rector of the Academy of National Economy, a member of the
Editorial Board for Voprosy Ekonomiki (Problems of Economic) journal, the Vestnik Evropy (Herald
of Europe) journal, The Predprinimatelstvo (Enterpreneurship), and the RAND Journal of
Economic Transition, etc. He has been a Senior Lecturer at the Economics Department of
Moscow State University, a head of department at the Institute of Economic Policy, the Fowler
Hamilton Fellow at Christ Church, Oxford, and lecturer in the Stanford University Overseas
department. He has held various government appointments, advisor to the Prime Minister of the
Russian Federation (1992-93), advisor to the First Deputy Prime Minister of the Government of
the Russian Federation (1993-94), deputy director of the Institute for the Economy in Transition
(1994-1997). In 1997-2002 he was the Director of the Working Center for Economic Reform of
the Russian Government and the Deputy Director of the Institute for the Economy in Transition.
Professor Mau has published about 20 books and 400 articles on history of economic thought,
political economy, social and political issues of market reforms, economic policy, etc.
Konstantin Yanovskiy
He obtained an MA (1997) from the State University - Higher School of Economics (Moscow)
and a Ph.D. (2003) in economics at the Institute for the Economy in Transition (Moscow).
Konstantin Yanovskiy specialises in issues related to institutional economics, public choice theory,
economic history. He has participated in numerous research projects on regional finance reform,
economic regulation issues, economic policy problems and others. His professional experience
includes work for the State Committee of Antimonopoly Policy, Federal Agency of the Affairs of
Bankruptcy of the State Property, Institute for the Economy in Transition (since 1999). He is an
author or co-author of publications on political economy of the reform, economic growth in Russia,
deregulation of the Russian economy and other issues.
7
Irina Sinicina
Irina Sinitsina, Ph.D. (Moscow State University, 1975) is a leading researcher at the Institute
of International Economic and Political Studies, Russian Academy of Sciences (Moscow, Russia)
and CASE's permanent representative in Russia, as well as a member of the Board of Directors of
CASE - Transcaucasus in Tbilisi, Georgia. She specialises in the analysis of social policy, including
social security systems, social services, labour market, income and employment policies in Russia,
Poland, Georgia, Ukraine and other FSU and Central /Eastern European countries. Since 1992,
she has advised Russian ministries, governmental agencies, and the Central Bank of the Russian
Federation on various social and employment policy issues. She is an author or co-author of over
40 monographs, chapters and articles published in academic magazines on the issues of social
policy, social security, income and employment policies in transition economies.
Rafal Antczak
Rafa³ Antczak graduated from the Warsaw University (1994, MA in Economics), and
Comprehensive Course in Market Economics at Joint Vienna Institute (1997). He specialises in
macroeconomic aspects of transition and in monetary policy. He participated in numerous
research and advisory projects, e.g.: in Ukraine, Kyrgyzstan, Kazakhstan, Moldova, and Belarus.
He is a co-editor of the Polish Economic Outlook Quarterly edited by CASE - Center for Social
and Economic Research (Warsaw) and is an author of numerous publications and press articles.
He has collaborated with the CASE Foundation since 1994.
Sergei Zhavoronkov
A researcher at the Institute for the Economy in Transition (Moscow). Graduated from the
Moscow State University with Diploma of Higher Education (1999). His chief research interests
focus on: institutional economics and public choice, regional economic strategy, state regulation
of the economy and pressure groups. He has participated in numerous research projects and is an
author or co-author of publications on deregulation of Russian economy, investment risk,
investment climate and other issues.
Alexei Shapovalov
Aleksey Shapovalov graduated from the Kiev Slavonic University (2001, MA in Enterprise
Finance), and Comprehensive Course in Market Economics at Joint Vienna Institute (2002) with
honours. Now he is preparing a Ph.D. at the Research Institute of the Ministry of Finance of
Ukraine on Ukraine's state debt sustainability. He has been working for CASE Foundation since
1998. His main area of interest includes fiscal policy, economics of the state sector and policy
analysis. Since the first issue, involved in development of the fiscal part of the Ukrainian Economic
Outlook.
8
1. Introduction
The purpose of this study is to analyze the course, determinants and political economy
of economic reforms in Russia conducted in the period 1985-2003. The year 1985 can be
considered an important turning point in Soviet/Russian history, marked as it was by the elec-
tion of Mikhail Gorbachev to the position of General Secretary of the Communist Party of
Soviet Union (CPSU) and (de facto) leader of the USSR. This nomination brought an end to
two decades of political consolidation of the communist regime connected with the name of
General Secretary Leonid Brezhnev and his short-living successors (Yurii Andropov and
Konstantin Chernenko), often referred to ex post as 'the stagnation period' (vremya zastoya).
Gorbachev initiated a series of important political and (to a lesser extent) economic reforms,
which led eventually to the collapse of the communist regime and the disintegration of the
Soviet empire in 1991. Thus, 1991 must be seen as another dramatic turning point in Russia's
contemporary history. From the end of 1991 onwards political and economic reforms have
been carried out by the new Russian state that emerged after the disintegration of the USSR.
This paper aims to explain the political and institutional determinants of economic
reforms in the Russian Federation. It has been carried out under the Global Research Project
on 'Understanding Reforms' organized and financed by the Global Development Network
(GDN)1 as one of 30 country studies covering a broad set of developing and transition
economies. It presents the project's intermediate results and will be the subject of further
discussion as well as analytical and editorial work in the near future.
The case of Russia is very important and interesting from the point of view of GRP
'Understanding Reforms' goals and agenda, for many reasons. First, all transitions from com-
munist regimes and centrally-planned economies to democratic capitalism represent a much
more complex, complicated and difficult reform experience than policy reforms observed in
developing countries, especially when they relate to just one or a few specific policy areas.
Thus, learning the transition experience, particularly in its early phase, can provide an
1For details concerning the 'Understanding Reforms" project see

http://www.gdnet.org/activities/global_research_projects/understanding_reform/index.html
9
extremely valuable empirical input to 'understanding reform' and provide answers to the
project's key questions: 'why reform?', 'what reform?', and 'how well did the reform per-
form?' (Fanelli and Popov, 2003; Schmidt-Hebbel, 2003).
Second, Russia had the longest and deepest experience of communism and the com-
mand economy. It was the first country to fall under communist rule and install a centrally-
planned economic system (as a result of the October revolution in 1917 and subsequent
Stalinist 'revolution' at the end of the 1920s and beginning of the 1930s) and lived under both
for the next seventy years. Historically, Russia was the largest test ground for and greatest
victim of Stalinist industrialization and collectivization of agriculture, with far-reaching eco-
nomic, social and demographic consequences. In fact, the whole structure of the Russian real
economy became heavily distorted in terms of sectoral/branch structure, giant size of enter-
prises, their often remote geographic locations, forced internal migrations, etc. Although
many developing countries in the 20th century tried inward-oriented import substitution
strategies (see Gaidar, 1997), none went so far in this kind of experiment as the former
Soviet Union. These extreme structural distortions created an additional social and political
burden, which heavily complicated the transition process.
Third, in contrast to other Central and Eastern European (CEE) nations (including the
Baltic ones), Russian society has had no living memory of a market economy, democracy and
civil society. Even before the Bolshevik revolution Russia represented a case of immature
capitalism (compared to Western Europe or the US) and had almost no experience of a
democratic system and rule of law. Thus, in the 1990s Russia had to build both a market
economy and democracy virtually from scratch2.
Fourth, the political economy of Russia's transition turned out to be extremely difficult.
This was not only the consequence of the complicated structural, institutional and socio-cul-
tural heritage (see above). The 'independence' factor, so powerful in many former commu-
nist countries (including some republics of the former USSR), was virtually non-existent in
Russia. On the contrary, many ordinary Russians and a significant part of the political elite
were upset by the loss of the Soviet empire (in its broader sense, including the former satel-
lite countries of CEE) and attributed this unfortunate (in their minds) event to democratic
and market reforms. As such, 'patriotism' in Russian politics came to be mostly closely asso-
ciated with opposition to market-oriented reforms (resembling the experience of many
developing countries) and weakened the support of Russian society to the reforms. This only
slightly changed at the end of the 1990s when advocates of a strong Russian state began to
understand that an efficient market economy is a basic precondition for achieving this goal.
Fifth, the dynamic of the reform process in Russia differed significantly from that of many
2
Although lack of democratic traditions and institutions could also be observed in many developing countries entering the
path of policy reforms (and, consequently, having to go through a 'dual' transition, both political and economic, similarly to post-
communist countries) they did have experience with market mechanisms even if the latter had been distorted by excessive gov-
ernment interference.
10
1. Introduction
other transition countries. While the pace and consistency of reforms through most of the
1990s was unsatisfactory, since 2000 one has been able to observe some acceleration in eco-
nomic and institutional changes. Particularly interesting is that this reform acceleration has
been underpinned by rapid output recovery and a substantial improvement in external eco-
nomic conditions (high oil prices). At first glance, this would appear to contradict the key
hypothesis that 'crises induce reform' and that politicians decide to change the status quo
only when they do not see any other way out (see Fanelli and Popov, 2003; Fidrmuc and
Noury, 2002; Ruis and van de Valle, 2003). However, in this particular case the reform accel-
eration of 2000-2002 can be linked back to a somewhat delayed lesson drawn by the politi-
cal elite from the August 1998 financial crisis.
Sixth, the sequencing of Russia's reforms differed from those recommended by many
experts and international financial institutions (IFIs) and from those experienced by the 'lead-
ing reformers' in Central Europe and the Baltic (CEB) region. In Russia, the mass privatiza-
tion process was launched prior to macroeconomic stabilization and liberalization of domes-
tic and external markets were completed. This means that a case study of Russia provides a
way of understanding the roots of this sequential differentiation and its consequence for
reform outcomes.
Seventh, due to strong historical and cultural links, political elites in many of the former
Soviet republics have sought to follow the Russian experience in reforming both their
economies and state institutions. It is, therefore, very difficult to understand fully the course
of the economic and political transition in the CIS countries without a good understanding of
what happened in Russia and why.
Eighth, the size and geopolitical importance of Russia would make any attempt to
exclude it from a large-scale comparative analysis of the factors determining the course of
successful/unsuccessful reforms very controversial.
Ninth, the same arguments, i.e. size of Russia, its military potential and geopolitical
importance, underpinned the substantial engagement of the international community, par-
ticularly the G-7 governments and IFIs, in assisting Russia's transition process in the 1990s.
However, the role and effectiveness of this support raised many controversies, both inside
and outside Russia. This allows us to test empirically a hypothesis on the role of external fac-
tors in leveraging the reform process (see Schmidt-Hebbel, 2003).
In line with the project's overriding guidelines and assumptions we understand econom-
ic reforms to be changes in economic institutions and economic policies leading to an
increase in the role of market mechanisms. In the case of post-communist countries, which
had to go through a 'dual' transition, i.e., had to change simultaneously and fundamentally
both political and economic systems, institutions must naturally be at the center of our
research interest. The nature of transition consists of very deep and far-reaching changes in
all basic institutions. However, because of the very fundamental nature of post-communist
11
transition, institutional changes seem to have taken on, to a certain extent, the character of
endogenous rather than exogenous variables. This is that they are an effect of the reforms
rather than independent factors determining their course and outcomes.
Consequently, in analyzing the transition process in former communist countries we con-
sider more or less revolutionary changes in the political elite as an exogenous factor deter-
mining the initial stage of political and economic reforms in the late 1980s and start of the
1990s (see Balcerowicz, 1994; Mau and Starodubrovskaya, 2001; Aslund, 2002; Dabrowski
and Gortat, 2002). In those countries where such elite changes went deeper a larger political
window of opportunity for reforming both political and economic institutions was opened.
Changes in economic and political institutions are strongly interrelated. Referring to termi-
nology proposed by Ruis and van de Walle (2003) we are seeking to determine how changes
in high level rules, i.e. political institutions, influenced the medium level set of rules, i.e. economic
institutions. However, we also want to look at the opposite relation, i.e. how economic insti-
tutions and the economic situation affected the political sphere and changes in political institu-
tions. In the case of Russia it would be particularly interesting to analyze how the imperfect out-
comes of the first stage of the economic transition helped so-called 'early winners' to 'capture'
key state institutions and their role in subsequently distorting the political system.
The dominant analytical framework for this study is that offered by political economy
analyzes. In addition, we have sought to draw from a large body of empirical studies investi-
gating interrelations between political and economic reforms, problems of building and sus-
taining pro-reform coalitions, the conditions conducive to opening political windows of
opportunity for radical reforms, reform cycles and the political costs of reform in relation to
both post-communist countries3 and other developing countries.
The thematic framework of the project directed our research efforts towards identifying
the political and institutional factors that have determined the course of economic reforms
in Russia and their changing fortunes. To obtain a fuller diagnosis we have adopted an inter-
disciplinary approach, involving the conceptual frameworks and research instruments pro-
posed by various academic disciplines such as political economy, sociology, political science,
political and economic history, institutional economics, macroeconomics, microeconomics
and social policy (the latter in relation to part of reform outcomes).
Our case study is mainly of a qualitative and narrative character. To economize research
efforts and financial resources we resorted to existing literature and research results on
related topics, including our own (CASE and IET) previous analyzes.
However, we have also sought to underpin our qualitative analysis with a more formal,
quantitative examination of political trends based mainly on electoral statistics. This analysis,
13
In the case of post-communist countries see e.g. FH (2001); World Bank (2002); EBRD (2000; 2001; 2002); Aslund (2002);
Dabrowski and Gortat (2002). Some active architects of the economic reforms have also delivered personal insights (see Gaidar,
1999; Klaus, 1997).
12
1. Introduction
based on the concept of public demand for reforms and new institutions, proposed by Mau
et al. (2001), and based on the theory of public choice and Balcerowicz's (1995) analysis of
the political economy of transition. If one assumes political parties in a transitional democra-
cy to be bearers of particular economic, social and political strategies, election results may
reflect voter demands for particular institutional packages.
The paper is organized as follows: Chapter 2 contains a short history of the Soviet/
Russian political and economic reforms. As well as 1985 and 1991, we have chosen 1994 and
1998 as two other turning points allowing a sub-periodization of our analysis. The first date
can be considered the end of the 'revolutionary' period of political and economic reforms. In
addition, the first full-scale currency crisis (so-called 'Black Tuesday' of October 11, 1994)
finally pushed the political elite to stop its openly pro-inflationary macroeconomic policy. The
second date was again marked by the full-scale currency, debt and banking crisis of August
1998 which opened (with a certain time-lag) the path towards a more responsible fiscal pol-
icy and more consistent strategy of both structural and institutional reforms.
Chapter 3 is devoted to empirical analysis of electoral behavior and presents two mod-
els (international and interregional), which seek to link the effects of economic reforms to
the electoral preferences of society and the basic institutions guaranteeing human rights and
civic freedoms. Chapter 4 analyzes the role of the international community in leveraging the
process of political and economic reform in Russia. Special attention has been put on actions
and programs undertaken by G-7 governments, the IMF and World Bank.
In Chapter 5 we present a broad set of economic and social indicators designed to illus-
trate the effects of the reform process in Russia. This is, however, a very complicated task as
economic and social performance may be affected by many factors other than the reforms
themselves. The potentially most logical approach – what would have happened if reforms
had not been undertaken or other reform strategies/sequencing had been chosen – is not
analytically feasible in its pure form. Counterfactuals can be the subject of interesting intel-
lectual speculation but cannot act as a sufficiently precise quantity simulation ex post. Thus,
comparative cross-country analyzes (particularly comparing Russia to more successful
reformers in the CEB region) was the only feasible research technique that might offer at
least a partial answer to this question (although, again, leaving a substantial margin for the
impact of other factors, such as different starting points and the geopolitical environment).
This approach has been largely used here where data availability and comparability have
allowed. Chapter 6, the last one, tests the study's central hypotheses. The analysis has a nar-
rative character and refers to findings and conclusions drawn from the preceding chapters.
13
2. History of the Soviet/Russian
political and economic reforms
1985-2002
2.1. The end of the communist 'economic miracle'
The stagnation, crisis and finally collapse of communist regimes did not result just from a
fatal coincidence of circumstances or political error. It was also an outcome of their deeply
rooted economic inefficiency. One can find detailed arguments to support the unavailability
of such an outcome in a number of publications, starting from the very early critics of the
socialist/communist economy at the beginning of the 1920s (see Brutskus, 1922; Mises,
1981) and ending with post factum analyzes of the economic and political roots of its collapse
(see Ofer, 1987; Gaidar, 1997; Gaidar et al., 2003; Aslund, 2002).
Olson (2000, pp. 100, 129) argued that under the Stalinist regime regular and large-scale
repression helped subdue special interest groups, thus providing relative transparency and
diminishing the losses caused by inefficient bureaucratic control. However, the classical total-
itarian model was significantly modified immediately after Stalin's because the Stalinist elite
was deeply concerned to protect its personal safety. The price paid for this immunity was
the gradual growth of an informal bureaucracy and special interests groups (Olson, 2000,
Chapter 8), further depletion of transparency and a deepening of systemic sclerosis.
In fact, very few people noticed the gradual weakening of the communist regime and
Soviet state. Domestic public opinion tended to over rather than underestimate the power
of the state. The same went for Western scholars and commentators, many of whom were
unable to forecast the collapse of the USSR even when it appeared unavoidable (see e.g.
Huntington, 1991).
Economic stagnation and gradual loss in geopolitical rivalry with the US and other
Western countries were the two main fields where signs of the coming decline first had been
noticeable. As result by the early 1980s the USSR had lost any real financial room for maneu-
ver it had had earlier. In order to continue economic expansion within the previous economic
model (and avoid any serious reforms) the Soviet economy had increasingly to resort to for-
14
2. History of the Soviet/Russian political and economic reforms 1985-2002
eign borrowing. Large-scale use of foreign credits resulted in a continuously growing debt-
service burden: USD 5.9 billion in 1984 and USD 15.1 billion in 1986.
When Gorbachev came to power in 1985 the economic situation was only superficially
stable (in the sense of Brezhnev-era 'stability'). Maintaining the then level of production and
consumption, let alone raising it, depended on uncontrollable external factors: world oil and
gas prices, discoveries of new oil and gas fields with low extraction costs and opportunities to
issue low-interest debt. However, a dramatic fall in world oil prices (almost twofold in 1985-
1986 compared to 1984 and more than threefold in constant prices compared to 1980 – see
Table 2.1) and an absolute decline in export earnings (USD 91.4 billion in 1983, and USD 86.7
billion in 1985) signaled a further deterioration in the financial situation. The USSR's failure in
the Arms Race was becoming unavoidable and obvious to the new leadership.
Diplomatic concessions granted in 1985-1989 to the US and other Western countries and
the 1988-89 political reforms issued a clear signal to society and the intellectual elites that
the Communist Party and Soviet government were weakening. The willingness to use power
(including physical repression) was perhaps the key factor stabilizing the socialist economic
system and the main condition of its efficiency and manageability.
Table 2.1. Spot crude oil prices, 1972-1998, USD/bbl
Year 1972 1973 1974 1975 1976 1977 1978 1979 1980
Dubai* 1.90 2.83 10.41 10.70 11.63 12.38 13.03 29.75 35.69
Brent† - - - - 12.80 13.92 14.02 31.61 36.83
Year 1981 1982 1983 1984 1985 1986 1987 1988 1989
Dubai* 34.32 31.80 28.78 28.07 27.53 12.95 16.92 13.19 15.68
Brent† 35.93 32.97 29.55 28.66 27.51 14.38 18.42 14.96 18.20
Year 1990 1991 1992 1993 1994 1995 1996 1997 1998
Dubai* 20.50 16.56 17.21 14.90 14.76 16.09 18.56 18.13 12.16
Brent† 23.81 20.05 19.37 17.07 15.98 17.18 20.81 19.30 13.11
Notes: * 1972-1985 Arabian Light, 1986-1998 Dubai; †1976-1984 Forties, 1985-1998 Brent.
Source: BP Amoco Statistical Review of World Energy, June 1999
The protracted fiscal crisis caused primarily (but not exclusively) by the fall in world oil
prices and anti-alcohol campaign considerably narrowed political room for maneuver (see
Gaidar, 1997, pp. 161-173). Bureaucratic and political conflict between different sectors
caused by their divergent interests (typical for a centralized industrial economy) overlapped
with the conflict between profitable and loss-making enterprises within sectors. A conflict
between strengthened regional elites and the central (Union) elite, as well as differences of
interests between individual Union republics and regions, were similarly exacerbated.
Increasing splits and tensions within the nomenklatura could be interpreted as a reaction to
the excessive stability of the 1970s and early 1980s when all personal mobility was effectively
frozen. All of this created a potentially ungovernable environment.
15
2.2. The destabilizing effects of the 'Perestroika' period 1985-1991
In his first attempt to overcome economic stagnation and political and social 'sclerosis'
Mikhail Gorbachev resorted to a typical 'mobilization' approach well-known from commu-
nist history. The slogan 'acceleration' (uskorenie) meant in fact a new industrialization drive,
as it was dramatically increasing savings and investment rates (by administrative means) and
shifting the bulk of resources towards development of the machine-building complex. At the
same time, the new leadership proclaimed the development of a consumer market (at least
partially) and its intention to increase living standards. Obviously, the two goals stood in con-
tradictory to one another (see Mau, 1996).
On the social front, two campaigns were initiated – an anti-alcohol drive and the 'fight
against non-labor incomes' – which had obvious negative effects for both public finances and
the prospects for liberalizing the economic system.
However, the key difference between the new leader and previous newly appointed
general secretaries (like Yurii Andropov in 1982) lay not in his rhetoric but in his clearly
demonstrated reluctance to use violence (liberation of dissidents, censorship softening).
From the very beginning 'openness' (glasnost') became the leading, and far from empty, polit-
ical slogan. The political atmosphere in the previously totalitarian state and society started to
change very quickly (see Grachev, 2001).
However, as mentioned in the previous section, actual or threatened coercion had acted
to guarantee the stability and manageability of the communist system. But with Gorbachev's
reluctance to use repression the mid-level nomenklatura (basically, managers of large enter-
prises) got the signal that Andropov's 1983 nightmare (massive arrests of managers under the
slogan of fighting corruption and imposing discipline) had been left in the past.
Furthermore, enterprise directors became the main beneficiary group of the economic
reform, which was an important component of the 'reconstruction' (perestroika) process.
The Law on State Enterprise adopted in 1987 gave state owned-enterprises (SOE) and their
managers substantial autonomy without financial responsibility. To some extent the new law
followed the experience of 'market socialism' reforms in Yugoslavia, Hungary and Poland,
although its conceptual and legal consistency was much lower, the external environment of
SOE activity remained mostly non-market (with most prices continuing to be administra-
tively set), macroeconomic policy much looser and enterprise budget constraints much soft-
er, all compared, for example, to Hungary or Yugoslavia.
In 1988 two other key systemic innovations were introduced. The Law on Cooperatives
gave more freedom in creating new firms in the legal form of co-operatives, as a 'pure' pri-
vate ownership had still not been legalized. The Law on Leasing allowed for partial owner-
ship changes in the existing SOE using the form of collective leasing (arenda). All three laws
16
opened the process of spontaneous de-etatization of the Soviet economy, mostly through
profit and asset stripping from the existing SOEs to new quasi-private entities. Profits were
in effect 'privatized' and losses 'socialized,' putting an additional burden on the deteriorating
state budget (which already suffered from low oil prices and the negative fiscal consequences
of the anti-alcohol campaign).
Overall, these partial and chaotic reforms did not create a coherent and critical mass of
changes. They were sufficient to destroy the command system but insufficient to build a new
market one and led to a loss both of microeconomic control over the economy (an owner-
ship and institutional vacuum) and the accumulation of huge macroeconomic imbalances (the
hidden hyperinflation of 1990-1991).
Because the political reforms of the Gorbachev period (partial political liberalization and
democratization) went further than the above described economic changes this discrepancy
created fertile soil for various kinds of social and macroeconomic populism. It also sped up
the process of disintegration of the Soviet empire, which was probably unavoidable anyway
under any political liberalization scenario. However, the process of political emancipation of
the national republics in the context of an insufficiently reformed economic system could do
nothing but add to the macroeconomic chaos. In 1990-1991 the Soviet authorities' effective
control over fiscal and monetary policies was progressively undermined by the republican
authorities, with the Russian Federation in the lead (see Dabrowski, 1997).
The last two years of the Soviet Union and Gorbachev's rule brought even more contra-
dictory attempts to resolve the mounting economic and political crisis (see Mau, 1996; Gaidar
et al 2003; Gaidar, 1999; Dabrowski et al., 1993). For example, the '500 Days Program' pre-
pared in summer 1990 by a group of young economists at the initiative of the government of
the Russian Federation (including the then Deputy Prime Minister Grigorii Yavlinskii) advised
far-reaching privatization, de-monopolization and building market structures as the first step,
followed by macroeconomic stabilization and price/trade liberalization as the final step (see
Yasin, 2003). The plan's authors unrealistically assumed that mass-scale cash privatization
alone would allow the budget to be balanced and problems of macroeconomic disequilibrium
to be resolved (the fiscal deficit was ex post estimated to reach a level of 31% of GDP in 1991
– see IMF, 1992, p. 13). However, they well understood that gradual reforms would not work
given the limited political resources available (window of opportunity)4.
The '500 Days Program' was formally accepted by President Gorbachev but never imple-
mented by the Soviet government of Prime Minister Nikolai Ryzhkov. When the latter was
replaced by the new government of Valentin Pavlov an attempt at a Soviet-conservative 'sta-
bilization' (see Mau, 1996) was undertaken at the beginning of 1991, involving a non-equiva-
lent exchange of old banknotes and administrative price adjustment. Both measures failed to
4 Ex post, voter support for economic reform weakened significantly after the April 1993 referendum and before the
December 1993 Duma elections – almost exactly 500 days after the reforms started in earnest in January 1992.
17
restore market equilibrium. Finally, the 'hardliners' made the dramatic and unsuccessful
attempt to save the totalitarian system and Soviet empire through a coup d'etat in August
1991. Their failure brought an immediate administrative dissolution of the CPSU and opened
the way to the final collapse of the Soviet Union at the and of 1991.
2.3. 'Revolutionary' period of reforms, end of 1991-1994
The dramatic events of 1991 – the unsuccessful coup d'etat in August 1991, the political
collapse of the USSR and severe macroeconomic crisis – created the foundations for the
democratic and market transition in Russia. The first post-communist government in Russia,
headed formally by President Boris Yeltsin and with an economic team led by Yegor Gaidar
and Anatoliy Chubais, prepared a comprehensive program for market transition, including
price liberalization, macroeconomic stabilization and mass voucher-type privatization. Both
the economic team itself and the designed program did not differ in terms of their profes-
sional quality from those observed in CEB countries. However, political support for market
reforms in Russia turned out to be weaker and more fragile than in more successful transi-
tion countries.
As result, reformers became politically isolated as early as the first few months of transi-
tion. They were forced to accept many compromises5, to form political alliances not based
on program principles and accept second- and third-best choices in order to be able to move
forward. This led to a slow pace of reform and inconsequent implementation, with many
dramatic turning points, which in turn further undermined political support for reform and
the reformers' own political leverage.
The basic factor underlying such difficulties was connected with only partial change of
political elite in the course of the 'revolutionary' events of 1991 and resulting problems orga-
nizing a stable pro-reform coalition. At the beginning of the transition, the political system
remained largely unchanged compared to the late-Soviet period. This played a large part in
leading to the dramatic constitutional crisis of 1993.
Only the series of 1993 political events – the April referendum, which confirmed
President Yeltsin's mandate to carry out economic and political reforms, the forced dissolu-
tion of the anti-reform parliament in September, the unsuccessful coup d'etat attempted by
leaders of the dissolved parliament in early October, the referendum and general election in
5 Such compromises were taken by political opponents as signs of the reformers' weakness and provoked further anti-reform
pressure (see Zhavoronkov and Yanovskiy, 2001). Compromise is a tool for coordination of interests in a stable democracy. It is
based on the refusal of both sides to use violence against one another. More precisely, compromise is based on a refusal to seek
damages clearly disproportionate to the value of a subject to any given dispute. Unfortunately, this kind of 'compromise culture'
did not exist in the first stage of transition in Russia.
18
December – opened the way to the adoption of the new post-communist constitution and
far-reaching changes in the political system. The constitution of 1993 was designed to
strengthen the prerogatives of executive power (a presidential-parliamentary regime), build
in the necessary checks and balances (mostly between legislative and executive branches of
government), prevent territorial disintegration of the Russian Federation and guarantee basic
civic and economic freedoms.
In spite of its pro-democratic and pro-market character the new constitution failed, how-
ever, to increase the political influence of the reform camp because communist and other
populist parties dominated the State Duma (lower house of parliament) until 1999. Only the
general pro-reform orientation of President Yeltsin, his determination to avoid a communist
restoration and his political skills in retaining a hold on political power and rotating reform-
minded politicians in subsequent governments6 kept the limited pro-reform momentum
going over the entire decade. On the other hand, Yeltsin's presidency can be characterized
by numerous weaknesses, such as the lack of a stable and well organized pro-reform politi-
cal camp, capricious and unpredictable personal policy, a strong populist bias in many deci-
sions and significant fluctuation in his public activeness, which was additionally complicated
by his serious health problems.
The above mentioned unfavorable political conditions did not prevent Gaidar's team
from conducting wide-ranging price liberalization on January 1, 1992. This was a critical step
in breaking with the command economy and allowed market forces to start working. It also
created room for future macroeconomic adjustment and the gradual elimination of market
distortions. Firstly, it was necessary to reduce fiscal imbalances, as many prices had been
previously heavily subsidized. Without free prices it would have been difficult to introduce
VAT. Secondly, price liberalization removed the monetary overhang created by the inflation-
ary policies of previous years. Thirdly, changes in relative prices laid the preconditions for a
more efficient distribution and use of scarce resources. Fourthly, free prices pushed enter-
prises to compete on the market. Finally, the disappearance of product shortages was
reflected in household behavior, which sharply reduced speculative demand and eliminated
long lines in front of shops and the black market.
Elimination of most foreign exchange restrictions and unifying the ruble exchange rate in
summer 1992 led to a reduction in explicit and implicit import subsidies. Opening up the
economy was as important as domestic price liberalization as it stimulated, within a short
period of time, a substantial inflow of consumer imports and provided a market solution to
the problem of chronic product shortages and the poor quality of the consumer market.
Elimination of export restrictions took more time (until 1994), creating serious distortions
13
Each year of the 1990s brought at least one serious reorganization of federal government. Although Viktor Chernomyrdin
kept his position of Prime Minister for a relatively long period of time (December 1992 – March 1998) economic portfolios in gov-
ernment were subject of frequent rotation.
19
and sources of rent extraction. Domestic energy and oil prices were never adjusted to the
international level, although they reached their highest level just before the August 1998 cri-
sis. Distortions led to income and wealth inequalities, continuing macroeconomic disequilib-
rium, various pathologies, etc.
Unfortunately, subsequent attempts at macroeconomic stabilization undertaken in 1992,
1993 and 1994 failed due to the strong resistance of well-organized lobbies of 'red' industri-
alists, agrarians, heavily subsidized regions and emerging oligarchs – early winners of the
incomplete liberalization, the palliative reforms of the Gorbachev period (see above) and
macroeconomic disequilibrium. In 1992-1993, anti-stabilization and pro-inflationary forces
dominated the Congress of Peoples Deputies (the highest legislative body at the time) and
the Supreme Council (the permanent legislative chamber), in turn therefore also controlling
the Central Bank of Russia, which was legally and politically dependent on the legislative
branch of government. In addition, the ruble zone, with fifteen independent central banks,
continued to exist, making monetary control virtually impossible. The process of introducing
national currencies in FSU countries was not completed before the second half of 1993 (see
Dabrowski, 1997, Odling-Smee and Pastor, 2001).
Mass privatization was the only institutional component of the initial reform package,
which was implemented quickly but at the price of many substantial compromises granted
to influential lobbying groups. The first of them concerned the dominant method of privati-
zation. What had been the subject of a long intellectual and political debate in other coun-
tries (in Poland such discussions lasted at least two years) had to be decided in Russia with-
in just a few months. The choice was made in favor of voucher privatization, which had been
started before only in the Czech Republic, the first country trying out this method. In spite
of continuous criticism of this privatization approach (Stiglitz, 1999a; 1999b; Ellerman and
Stiglitz, 2000), the decision taken at the time seems now to have been the right one. Firstly,
other methods of privatization would not have brought fast ownership changes in big enter-
prises for technical reasons. Secondly, this was the only politically feasible method at the
time. Thirdly, it allowed the spontaneous and non-transparent privatization based on the
ownership experiments of Gorbachev era (see above)7 to be halted.
For the same political reasons, which largely inclined towards voucher privatization, the
government accepted the compromise, giving a significant stake of shares to insiders (employ-
ees and managers). This slowed down the process of enterprise restructuring but made it
possible both to get parliamentary approval and to create a strong interest in ownership
changes at the enterprise level. The experience of Ukraine a few years later showed that
smaller privileges to insiders can lead to lower interest in privatization from this important
social constituency and, therefore, to a very slow pace of this process (see Snelbecker, 1995).
7 This quasi-privatization method has been strongly defended and advocated by Stiglitz and Ellerman [2000]. See also polemics
of Dabrowski, Gomulka, and Rostowski [2001].
20
What was worse, the very strong political position of various branch lobbies and 'red'
directors made carrying out mass de-concentration and de-monopolization as the step pre-
ceding privatization (as was done, for example in Poland, Hungary and the Baltic countries)
impossible. This also complicated the restructuring process, made the domestic market less
competitive and contributed to the emergence of powerful industrial-financial groups.
Additional distortions came from the unfavorable macroeconomic and microeconomic envi-
ronments in which privatization had to be conducted: very high inflation, incomplete liberal-
ization and lack of a proper legal and regulatory environment, including law enforcement.
At the beginning of 1994, after most reformers (apart from Deputy Prime Minister in
charge of privatization Anatolii Chubais) had left the government following December 1993's
parliamentary election, the mass privatization program came under threat. The supply of
shares was insufficient to cover all vouchers and the earlier set deadline for the program of June
30, 1994 was moving ever closer. In this context, another controversial decision was taken: to
offer a significant portion of shares in two large energy monopolies – RAO EES (United Energy
Systems) and Gazprom – in exchange of vouchers. This step saved the voucher program but
seriously complicated the further process of restructuring both monopolistic giants.
When mass privatization was wound down and the cash privatization that followed had
problems taking off (for political and administrative reasons) a group made up of Russia's
largest private banks came up with a 'loans-for-shares' scheme (zalogovye aukciony). The gov-
ernment (including its reformer wing) accepted the idea in 1995. The rationale here was pre-
dominately political: to enable privatizations blocked by anti-reform groups in the govern-
ment and parliament and reward the oligarchs who had promised support for President
Yeltsin in the 1996 presidential election (see Yanovskiy, 2001).
However, the 'loans-for-shares' scheme increased the non-transparency of the Russian
privatization process and brought several negative consequences. Firstly, the federal budget
lost potential proceeds as the most attractive assets were sold far below their potential mar-
ket price. Secondly, this scheme helped to build strong financial-industrial groups control-
ling Russia's economic and political life over the next few years. Thirdly, the societal legit-
imization of the privatization process was seriously undermined.
In fact, a very similar political concession had been granted to the emerging oligarchs two
years earlier, before the December 1993 elections. At that time, President Yeltsin issued a
decree demanded by the Association of Russian Banks and supported by all reformers in the
government, which seriously restricted the entry of foreign banks into Russia. This heralded
the beginning of unfavorable developments in the Russian banking sector, lacking in proper
competition, and eventually contributed to the 1998 banking crisis.
Reformers had to pay a very high political price for some of the above-described compro-
mises. Firstly, they were blamed for building a crony capitalism that, at least partly, had
stemmed from the above-mentioned compromises. In the popular view, the free market (which
21
had never really existed in Russia) became associated with oligarchic fortunes and numerous
economic and social pathologies. Secondly, the reform camp's political room for maneuver
became increasingly limited because it had to fight not only with the supporters of the old eco-
nomic regime but also with omnipotent oligarchs who dominated Russian politics (capturing all
branches of government, particularly the executive) in the second half of the 1990s.
The slow pace and inconsistency of the Russian economic transition prolonged the period of
deep output decline and dramatically increased income and wealth differentiation (see Chapter
5). Politically, it resulted in increasing support for populist forces, reflected in the relative success
of the communists and their allies in the December 1995 elections to the State Duma.
2.4. The fragile and illusory stabilization of 1995-1998
The macroeconomic and political shock caused by the fully-fledged currency crisis (so-
called 'Black Tuesday' of October 11, 1994)8 forced the authorities to seek ways of restoring
macroeconomic stabilization in 1995. This resulted in gradually decreasing inflation to a low
two-digit level. However, this stabilization ultimately proved fragile and illusory because of
consistent and serious flaws in the fiscal and structural spheres: the weakness of the basic
state institutions, insufficient structural reforms, unreformed social policy, agriculture and
energy sectors, paternalism and soft budget constraints in relation to larger enterprises
reflected in an explosion of non-payments, arrears and barter transactions.
Figure 2.1. General Government Budget Balance
4
2.9
1.9
2 1.1
0
Proficit/Deficit, % to GDP
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
-0.9
-2 -1.3
-2.9
-4 -3.4 -3.2
-4.4
-4.9
-6 -5.2
-5.6
-8
-10
-9.9
-12
Years
Sources: RF Central Bank www.cbr.ru: 'Russian Statistical Yearbook 2002', State Statistics Committee, Moscow, 2002: 'Russia in
Figures 2003', State Statistics Committee, Moscow, 2003.
8
In fact, the ruble depreciated substantially earlier – in September 1992 and September 1993 – but this did not lead to an
immediate correction in macroeconomic policy.
22
After some fiscal tightening at the end of 1994 and 1995 the general government deficit
started to grow again in 1996-1998 (see Figure 2.1), as a consequence of the presidential elec-
tion campaign in 1996, the post-election political instability connected with President Yeltsin's
poor health and frequent changes in government, the deep-seated political conflict between
the mainly market-oriented government and communist-dominated Duma, serious flaws in
Russian federalism and the increasing influence of the oligarchs. The lack of a pro-reform
majority in the Duma and increasing political strength of the oligarchs may be considered the
most important factors hampering necessary fiscal, structural and institutional reforms.
The history of the two pre-crisis governments in particular is very telling. In the face of a
rapidly increasing fiscal deficit, public debt and slow pace of structural reforms, President
Yeltsin decided in February 1997 to reorganize the government of Prime Minister Victor
Chernomyrdin by nominating three new Deputy Prime Ministers, Anatolii Chubais, Boris
Nemtsov and Oleg Sysuev and other reform minded ministers (known as the government of
'young reformers'). The new cabinet's program included, among other things, a balanced
budget based on realistic macroeconomic assumptions, fundamental reform of social assis-
tance, targeting it towards the most vulnerable groups in society, a set of anti-corruption
measures, including transparent public procurement procedures, an obligatory declaration of
personal income and property by civil servants, moving budget accounts from private banks
to the Treasury, the elimination of barter transactions, netting-out operations and money sur-
rogates, the development of local self-government, open and transparent privatization ten-
ders, regulating natural monopolies and improving tax enforcement in relation to larger tax-
payers (see Zhavoronkov, 2001, Chubais, 1997)
However, this program was immediately met by the fierce resistance of the oligarchs.
The first relatively transparent privatization tender, of Svyazinvest in June 1997, provoked a
so-called 'war of the oligarchs' war, with a massive attack on the 'young reformers'. As a
result, the first government with a comprehensive program of structural and institutional
reform failed completely to carry them out.
By the time the first signs of financial crisis appeared in November 1997 the government
of the 'young reformers' had already lost its political momentum. The same happened with
the next reform-minded cabinet, of Sergei Kiriyenko, which was appointed in April 1998. As
a result, reformers were unable to convince the Duma of the need to carry out any of the
fundamental reforms needed to improve the fiscal situation and avoid financial crisis and had
to concentrate, in fact, on managing the crisis and calling for international assistance (Gaidar
et al., 2003; Zhavoronkov, 2001). Finally, they also had to take all the blame for the August
crisis and lost any opportunity to influence economic policy for at least a year.
The main macroeconomic differences compared to the 1992-1994 period were: much
tighter monetary policy and financing most of the fiscal deficit through Treasury bills and
bonds. However, this was not enough to guarantee macroeconomic stability in the longer
23
term. When the external environment deteriorated as a consequence of the Asian crisis, i.e.
international oil prices decreased and financial investors started to be less enthusiastic about
investing in emerging markets, Russian resistance to speculative pressure against its curren-
cy and Treasury securities crumbled. These unfavorable developments led to a large-scale
financial crisis, whose first symptoms were observed in the fall of 1997 but which fully erupt-
ed in August 1998.
2.5. Post-crisis period (1999-2003)
The August 1998 crisis was a dramatic turning point in the history of the Russian eco-
nomic transition (see Antczak, 2003). The more than three-fold devaluation of the ruble
brought a new round of inflation and depreciated, in real terms, wages, salaries, pensions and
other sources of income. The collapse of many 'oligarch' banks undermined the credibility of
the financial system and provoked a new wave of dollarization. However, the immediate
consequence of ruble devaluation and decreasing real wages was to help many domestic pro-
ducers (particularly in the import-competing sector) to take off9.
Default on government securities closed the Russian government's access to international
financial markets, enforcing fiscal adjustment and hardening financial discipline, which had ear-
lier been politically impossible10. Paradoxically, this adjustment was conducted by the left-wing
government of Prime Minister Evgenii Primakov backed by the communists and their allies in
the Duma despite its temptation to experiment with various populist and anti-market ideas11.
The December 1999 elections to the Duma and March 2000 Presidential elections recon-
structed Russia's political landscape. For the first time parliament was supportive of the mar-
ket-oriented policies of President Vladimir Putin and Prime Minister Mikhail Kasyanov and
their legislation initiatives. This significantly helped speed up the pace of economic and insti-
tutional reform and made it possible for Russia not to lose out on any external windfall gains
(in the form of high oil prices). Russia has enjoyed a fiscal surplus for the entire period under
consideration and the Russian economy has started to grow at quite an impressive rate.
A number of important reforms have also been undertaken, including the consolidation
of state institutions, improving the structure of Russian federalism (including in the fiscal
9 A more detailed analysis of the sources of economic growth in 1999-2002 can be found, inter alia, in IET (2003) and
Dabrowski (2003).
10 Fiscal adjustment was partly possible due to the halting of public debt servicing after August 17, 1998.
11 Several such ideas were elaborated at the end of 1998 by the group of distinguish Soviet-era academics and 'reformers'
(Leonid Abalkin, Dmitriy L'vov, Nikolai Petrakov, Stepan Sitaryan and others). They advised, for example, 'pumping' the money sup-
ply to reach a monetization level (M2/GDP) equal to Western European or at least Central European countries. They were also
in favor of 'selective' government investment programs in industry. See Zhavoronkov (2001) for analysis of the economic policy
dilemmas of Primakov's government.
24
sphere), the reconstruction of the legal system and judicial branch of government, simplify-
ing the tax system, changing the pension and health systems, adjusting housing and munici-
pal services to the market environment and realities, restructuring and regulation of natural
monopolies (electricity generation, transportation and supply, railway transportation), mak-
ing land resources (including agriculture land) tradable, deregulation of business activity and
advancing Russia's accession to the WTO. However, one must remember that the concep-
tual basis for many of these reforms had been worked out earlier, sometimes much earlier
(for example, in the early 1990s) and it was only a matter when the political window of
opportunity would open for them to start in the recent period. In addition, most of these
reforms are still only at the conceptual and legislative stages or their implementation was
started not long ago.
2.6. The overall record and list of unresolved problems
The results of the Russian economic transition raise many controversies, sometimes of a clear-
ly emotional character. In attempting to define the overall progress made in building a market econ-
omy in Russia one might choose the term 'moderate', that is compared to other transition coun-
tries: the 'fast' reformers of the CEB region, on the one hand, and the 'slow' reformers, such as
Ukraine, and the 'non-' reformers, such as Belarus, Uzbekistan and Turkmenistan, on the other.
Without any doubts, the Russian economy can today be considered predominantly market-
based, something that seemed an unrealistic dream until the end of the 1980s. The temptation
to return to a command economy, which has been experimented to some extent in neighbor-
ing Belarus and which seemed to be a real danger in Russia at least until the 1996 presidential
elections, no longer appears to be a real danger. Institutional and ownership changes have gone
too far to be easily reversed and the main political forces (including the Communist Party of
the Russian Federation) are apparently not interested in such an approach.
The international perception of Russia's economic transition has changed dramatically in
the course of the last few years: from deep criticism and extreme pessimism in the aftermath
of the 1998 financial crisis to acknowledgment of the reforms that have been conducted and
the prevailing view in many parts that Russia is a promising reformer.
However, some important enclaves of the old economic system (only slightly modified)
have yet to disappear. In first instance this relates to agriculture, communal housing services,
a significant chunk of the energy sector, most of the country's social services and its social
safety net, including the pension system. Other sectors, mainly the natural monopolies, suf-
fer from huge distortions due to the lack of transparent regulation, excessive politicization,
incomplete and non-transparent privatization, administratively imposed low user tariffs, etc.
25
These sectors remain the objects of intensive rent seeking by competing groups of oligarchs.
The list of unresolved problems contains also several other items such as:
• Poor investment climate caused by lack of effective protection of property rights and
personal immunity, weak contract and law enforcement and a poorly working justice
system. This has damaged first and foremost SME (see Mau and Yanovskiy, 2002 for
detailed analysis) but also FDI.
• Chronically underinvested infrastructure, with growing economic and technical risks.
• Ineffective, unreformed and costly army, police (militia) and security (Federal Security
Service – Russian acronym FSB) forces and excessive militarization of the Russian state
and economy as legacies of the totalitarian system (see Yasin, 2002). The militia and
FSB cannot provide elementary security to citizens and business, being instead a fre-
quent source of business harassment, violation of civil rights and corruption.
26
Appendix 2.1: The Main Reform Events and Players, 1990-2003
Year / stage/ ‘Red’ directors Regional elite Advocates of Military, police and ‘Oligarchs’ Pro-reformist coalition
program lobby communist state security elite (intellectuals, small,
‘restoration’ medium and, partly, big
business, etc)
1990/ late First opportunities - - Not existed Appearance and de -facto
‘Perestr oika’/ of strengthening legitimization of anti -
Ryzhkov -Abalkin their autonomy communist opposition,
program; 500 removal of Article 6 -of the
Days program Constitution of USSR, which
gave CPSU the ‘ruling role’
1991/ late Tax privileges, Regions’ - - Not existed Laws on the property, business
‘Perestroika’/ concessions in ‘sovereignty’ (by - activity, competition,
Pavlov’s program the privatization product of Yeltsin - privatization; defeat of coup
legislation Gorbachev rivalry d’etat in August 1991

1991 – start of - - - Status-quo Not existed Collapse of USSR; Pro -reform
‘revolutionary’ preservation choice of the President and
reforms / Congress of Peoples Deputies
Gaidar’s program (CPD); Formatio n of reform
government; preparing basic
reform steps
1992 – start of Price and trade - President’s Status-quo Origins: high Price and trade liberalization
‘revolutionary’ liberalization, compromise with preservation; inflation and Start of large -scale
reform / program subsidized CPD in December autonomy in budget keeping budgetary privatization
of Yeltsin - Gaidar credit lines from 1992: Gaidar’s management accounts in
government summer 1992, resignation, calling "friendly" banks
acceptance of off referendum on
state holdings, land privatization
insiders’
privilege s in
voucher
privatization,
soft budget
constraints
1993/ reform As above Concessions in Unsuccessful As above High inflation and Boris Fedorov becomes the
slowing down/ - privatization; attempt to restore budgetary Minister of Finance, dissolution
opportunities to get price control, accounts in of CPD, adoption of the new
benefits from the compromises with "friendly" banks, Constitution, the first free
conflict between sectoral and import and export parliamentary elections, small
legislative and territorial lobbies control, low costs and voucher privatization takes
executive branches of obtaining off
27
privatized assets
28
business, etc)
1994/ end of Soft budget - Budget concessions, Status-quo Soft budget Surviving of pro -reform wing in
‘revolution’ constraints government preservation, constraints, government, adoption of the
period/ - nominations (e.g., forgiveness for beginning of issue Civil Code (Part One)
Ministry of Justice, passive behavior of Treasury bills
Ministry of during October 1993 (GKO)
Agriculture) rebel, Chechen War -I
1995/ beginning Government Active As above Stopping reform of Disinflation, Disinflatio n, adoption of the
of ‘post - non-intervention ‘participation’ in the army and police, massive issue of Civil Code (Part Two)
revolution’ against privatization Continuation of the GKO, ‘loans -for-
stabilization/ - managers’ process Chechen War -I shares tenders and
abuses of other ‘addressed’
property rights privatization deals
1996/ As above plus As above plus As above plus As above Continuation of Adoption of P enal Code, anti -
presidential subsidized automatic resignation of privatization communist rhetoric of
election - credits and tax membership in the Chubais, control abuses, partial President Yeltsin, vetoing laws
stabilization forgiveness Federation Council over General privatization of the adopted by pro -communist
interrupted (upper Chamber of Prosecutor’s office 1-th and 4 -th TV majority in the Duma, end of
(December 1995 Parliament) channels (to Boris the Chechen War -I
July 1996) / - Berezovskiy and
Vladimir Gusinskiy
1997/ illusory Gradual The same plus - Military reform Weakening ‘Young reformers’ (Nemtsov –
stabilization / -. decomposition – regional electio ns compromised Chubais and Chubais) cabinet, first cases of
end of (elimination of Nemtsov competitive pri vatization
autonomous conscription delayed positions, Kokh (Svyaz’invest ); fighting large tax
role indefinitely) and Boiko avoiders, first attempt of
resignations after military reform (army
the ‘book’ scandal downsizing), blocking left -
winger parliament initiatives,
decree on public procurement
business, etc)
1998/ financial - Regional price Resignation of As above Resignation of Appointment of Kiriyenko
crisis/ ‘academics’ control and trade Kiriyenko cabinet, Kiriyenko Government
program, barriers after Primakov -Maslukov government
alternative August financial left-wing
approach by IET crisis government Viktor
Gerashenko replaces
Sergei Dubinin as
CBR Gover nor
1999/ post -crisis - Active participation - Chechen War –II, Active influence -
period / - of regional leaders weakening of political on formation of

in parliamentary control Stepashin
election: success of government
recipient regions
2000/ post -crisis - Regional governors Getting position of As above, first ‘spy’ Gradual ousting of PIT flat rate
period / Greff lost seats in the Speaker and number trials, taking new non-loyal oligarchs
program Federation Council of committees in the business under (Berezovs kiy,
but got possibility of Duma; partial control Gusinskiy) while
a third term, restoration of Soviet loyalists survived
removal of some state symbols
governors in an
election process,
limited unification of
regional laws
2001 / post -crisis - - - As above Non-loyal Deregulation and partial
period / Greff oligarchs in exile reduction of regional
program administrative barriers
2002 / post -crisis - - Loss of key positions As above - Beginning of railroad and RAO
period / Greff in Duma; UES reform; adoption of law
program on technical regulation
2003/ post -crisis - Regional and - As above plus attack Attack against -
period / Greff ‘oligarchic’ elites against YUKOS YUKOS, regional
program overflowed United and ‘oligarchic’
Russia election list elites overflowed
United Russia
election list
29
Appendix 2.2. Main institutional changes in Russia, 1985-2003
This appendix contains a list of the main institutional reforms undertaken in the analyzed
time period, 1985-2003:
The Gorbachev period, 1985-1991

• Law on State Enterprise, 1997
• Law on Cooperatives, 1998
• Law on Collective Leasing (arenda), 1998
• Political reform since 1988
Period of 'revolutionary' reforms, 1991-1994

• Law on Competition, 1991
• Law on Privatization, 1991
• Law on Militia, 1991
• A new structure of the government of the Russian Federation: elimination of most of
the sectoral ministries (Presidential Decree No 172 of 6 November 1991)
• Price and trade liberalization, 1992
• Law on Consumer Rights (1992)
• Privatization decrees (particularly, No. 66 and 721 of 1992)
• Privatization Law 1992 version
• Decree 1400 of 21 September 1993 dissolving the Congress of Peoples Deputies and
Supreme Council
The Constitution of 12 December 1993
The period of fragile and illusory stabilization, 1994 -1998

• Civil Code, Parts One and Two;
• Criminal Code;
• Arbitration Procedure Code,
• Federal constitutional laws on the judiciary system and the Constitutional Court
• Law on the Fundamentals of Civil Service
• Law on budgetary classification
• The onset of reform in the housing and communal utilities sector
• Partial reform of military forces
• Partial tax reform: approval of Part One of the Tax Code
• Budgetary Code
• Law on Judiciary Department of the Supreme Court
30
• Draft law "On the licensing of certain activities", September 1998)

• Federal Constitutional Law "On Government"
The post-crisis period, 1999-2003

• Law "On quality and safety of food products" and relevant regulations, January 2000
• Tax reform: Part Two of the Tax Code
• Land Code and Land Turnover Law
• Onset of the judiciary reform
• Law on Status of Judges (significant simplification of dismissal procedure of judges)
• Criminal Procedural Code (with some new weak guaranties of personal immunity)
• Arbitrage Code, 2002
• The first package of laws on deregulation of the economy, August 2001
• Law on Technical Regulation, December 2002 (liberalization of technical regulations
and state standardization)
• Railroad reform bills, January 2003
• Debate on reform of the electricity sector and gas industry, beginning of restructuring
of the electricity sector
Appendix 2.3: Professional and political debate on economic

problems and economic reforms. Major government economic
policy and economic reform programs
This appendix presents a simple overview of the major approaches to economic reform pre-
sented in the analyzed period. We have classified them using two groups of criteria: (1) mar-
ket/non-market orientation, and (2) implementation realism and macroeconomic responsibility:
• Realism/ Market • Etatist/ interventionist • ‘Free market’
approach
• ‘Realist’, i.e. supplied with • Ryzhkov/ Abalkin • Economic Policy Institute
legislative ‘technology for government program of (Gaidar) program of 1991
implementation’ and taking 1990 • Government (Gaidar)
into consideration (at least • Pavlov government program of 1992;
partly) macroeconomic program of ‘administrative • Greff program and its
constraints stabilization’ of 1991 ‘clones’ based on
proposals of pro -reform
think-tanks (2000 -2003)
• ‘Unrealistic’ (in the sense of • ‘Academics’ program of • ‘500 days’ Program of
its implementation) and 1998 1990
macroeconomically
irresponsible (populist)
31
3. Political economy of reform – an
attempt at a quantitative analysis
3.1. The importance of election statistics
The main objective of this chapter is to develop a quantitative technique for assessing
public demand for reforms and new institutions, a concept elaborated by Mau et al.
(2001) and based public choice theory and Balcerowicz's (1995) analysis of the political econ-
omy of transition.
Our basic assumption is that voter preferences significantly influence the type and par-
ticular features of the institutions being formed and, through them, the dynamics of macro-
economic parameters.
If one considers political parties in a transitional democracy to be bearers of particular
economic, social and political strategies, election results can reflect voter demands for par-
ticular institutional packages. Such an approach needs, of course, to identify the economic
and political doctrines offered by political parties and leading politicians and an adequate
translation of them into exogenous variables that can be tested using a formalized model (see
Mau et al., 2001 for a detail methodology).
Although we are fully aware of the methodological risk connected with quantifying qual-
itative parameters12, we have sought to work on the experience already accumulated in pre-
vious IET research in this field. We have in mind formalized models explaining growth per-
formance (Mau and Yanovskiy, 2002) and investment risk in regions of the Russian Federation
(Mau et al., 2002 b; Yanovskiy et al., 2001) using a set of quantified political/ historical/ cul-
tural variables related to electoral preferences, political programs, ability to build pro-reform
coalitions, their sustainability, the historical traditions of democratic movements, the consol-
idation or fragmentation of political elites, access to free media, etc.
12 Which has been demonstrated, among other things, by the numerous shortcoming of such respectable international rat-
ings as those proposed by the EBRD (index of institutional reforms), Transparency International (corruption index) and the
Heritage Foundation (Index of Economic Freedom). In spite of their weaknesses we use the results of these ratings in Chapter 5.
32
3. Political economy of reform – an attempt at a quantitative analysis
Election results may be also interpreted (with the help of existing sociological research)
for an assessment of certain components of human capital (the ability to adapt, 'social opti-
mism'13, the attitude to civil self-organizations and cooperation, tolerance levels, etc.).
Several hypotheses were tested using two comparative statistical models (international and
interregional), which are elaborated below. Both were based on a common approach and ideas
but differed somewhat in terms of the sets of variables they used. The federal election data was
used for the interregional test and national election outcomes for the international test.
3.2. The basic model
The significance of political and the associated institutional factors is illustrated using a
modified Solow (1956) model. Let us assume that the rate of savings is not exogenously
determined but depends on investors' estimates of political and legal risks:
s = s (Rpolitical, Rlegal, …); y = y (s, …) (3.1)

- - +
where s – saving rate; R – investors' risk estimation; y – GDP per capita.
We assume that estimation of investors' political risk decreases with an increase in elec-
toral support for the reformist coalition. The GDP record of transitional post-communist
democracies in 2000 relative to 1989 can be explained with R2= 0.34 and T-statistics=3.127
by voting for reformist parties. Taking in consideration other forms of reformist (counter-
reformist) support, a reformist government and reformist majority in parliament during the
first years of transition we arrive at R2=0.548 (see Mau et al., 2001 for details). Both factors
– a reformist government supported by a reformist majority in parliament – are interpreted
by us as the actual window of opportunity for pro-market reforms.
The Russian regional test shows a strong dependence of electoral behavior on the results
of the first free elections. Duma election voting for the reformist block 'Vybor Rossii' ('Choice
of Russia') in December 1993 can be explained with R2= 0.677 by voting for Boris Yeltsin on
June 12, 1991 (the first free presidential election) and "Yes" to the economic reform policy at
the April 1993 referendum. Even the 1999 Duma election shows a statistically significant
dependence between support for the SPS (Right-Forces Union) and support for Yeltsin in
1991 with R2= 0.227 (see Mau et al., 2001 for details).
13 See, in particular, a survey by the 'Obshestvennoe mnene (Public Opinion)' Foundation on the results of the 1999 election,
which is posted on the website www.fom.ru, according to which, of Russia's citizens most able to adapt, 17% voted for the pro-
reform SPS (with a national average of 8.5%); while 32% of voters least able to adapt were among supporters of the Communist
Party (25%).
33
3.3. The International Analysis
Our international model covers CEE countries for the period 1989-1999 (apart from
Albania, Transcaucasus and Belarus), post-war Germany (1947-1957), Italy (1946-1956) and
Japan (1946-1956).
We try to explain GDP dynamics using a set of political and institutional variables. Among
the political ones the most important turned out to be:
• Electoral support for anti-reform lists – total votes for the radical left and nationalist
blocs (on average for all parliamentary elections)14
• Electoral support for social-democratic and conformist lists – total votes for the left
and socialist parties that do not fall under the definition of 'radical'
• Electoral support for conservative-liberal (pro-reform) parties
• The rule of a pro-reform cabinet in the first two years after fall of a totalitarian regime
• A pro-reform majority in parliament in the first two years after the fall of a totalitarian regime
• The number of years in office of pro-reform cabinets (in the first decade of reforms);
• The number of years of a pro-reform majority in parliament (out of the first decade of
reforms);
• 'Revolutionary' demand for new institutions measured by number of participants in
mass actions per 1,000 of the population.
Table 3.1. International model: results of a simple regression analysis
No. Independent variable (dependent – GDP dynamics) Coefficient value T-statistics
1. Voting for pro -reform parties 0.616 3.127
2. Participation in mass actions of the revolutionary period 0.515 2.402
3. The number of years in office of pro -reform cabin ets 0.609 3.069
(out of the first decade of reforms)
4. The rule of pro -reform cabinet in the first decade after fall 0.448 2.004
a of totalitarian regime
5. The pro-reform majority in parliament in the first two years 0.662 3.538
after fall of a totalitarian regi me
6. Court prosecution of the functionaries of totalitarian regime 0,357 2,535
Source: Mau et al. (2001), Mau et. al (2003).
All the explanatory variables are obviously interdependent. For example, the average
level of support for the pro-reform parties influences the number of years in office of pro-
reform cabinets; a special but very important, and therefore highlighted, case is rule by a
one-party pro-reform cabinet in the first two years. Also, the number of years of a pro-
reform majority in parliament and the existence of such a majority at the start of reforms are
determined by the average level of support and are interconnected.
14 See Mau et al. (2001, Appendix) on the criteria for classification of the political parties used in this analysis
34
Table 3.2. Summary Data on Regressions from the Principal Components

Dependent Adjusted
Groups of independent variables T- statistics Significance
variable R Square
GDP 10 / GDP 1 (for Election support for reformers 3.190 0.548 0,007
transition countries Mass actions against totalitarian regime 2.787 0,015
– GDP 2000 /GDP 1989 ) Lack of support for anti -reformers 2.375 0.032
Source: Mau et al. (2001).
That is, the factors cited are linked in a 'chain-like manner', but still supplement each
other, enhancing the explanatory power of the model. Such a situation makes it justified and
necessary to use the factor analysis method in the international model. As distinct from sim-
ple regressions, whose explanatory power does not exceed 0.3-0.35, the model as a whole
gives an explanation of more than 0.5 (see Table 3.2).
Restrictions on the electoral rights of key functionaries from the totalitarian regime also
positively influenced the model's results (see Regression 6 in Table 3.1).
In addition, we executed a number of statistical tests for various institutions. Taxation,
banks and insolvency legislation, business registration and licensing and the number of other
institutions appears to be statistically insignificant or less significant than the basic institution-
al guarantees of human rights and civil liberties illustrated by such variables as number of
appeals to international courts, free activity of opposition media, etc. (see Mau et al., 2003a;
b, for details).
3.4. The Interregional Analysis
The interregional model based on economic and electoral statistics of 78 Russian regions.
Electoral statistics covered three elections to the State Duma: 1993, 1995 and 1999.
3.4.1. The significance of the pro-reform coalition
In the interregional model we tested two dependencies. The first one concentrated on
election preferences and was similar to that described in equation 3.1. However, in the
absence of good quality and really comparable data on Gross Regional Product dynamics we
used other indicators such as rate of growth in number of cars per 1000 residents, person-
al income tax (PIT) revenue, foreign investment stock in the region and employment in the
small business sector.
35
Table 3.3. Interregional model: Summary Data on Simple Linear Regressions

No. Dependent Independent T-statistics Adjusted R Significance
variable variables Square
1. Relative increase in Dummy on the 4.454 0.316 0.000
the number of cars Regions with common
per 1000 residents border with Belarus.
Poland and Japan 4.104 0.000
Voting for pro -reform
parties
2. same Votes cast for anti - -2.956 0.248 0.004
reform parties
3. Foreign Voting for pro -reform 4.260 0.186 0.000
investments, 1998. parties
4. Personal income Voting for pro-reform 3.523 0.132 0.001
tax revenue parties
increase coefficient
(PIT 1999 /PIT 1994 )
Source: Mau et al. (2001).
The independent variables also needed modification. While the first three political vari-
ables were similar to the variables in the international model it was not possible to collect
regional data on variables other than just election results. Thus, the explanatory power of the
model became weakly comparable with the international one.
Hence, in order to increase the explanatory power of the interregional model, three vari-
ables were added, reflecting the peculiarities of Russian political history in the transition peri-
od. These were: voting for Yeltsin in the June 1991 presidential election, voting in support of
economic reforms at the April 1993 referendum (answer "Yes" to the second referendum
question) and voting for Yeltsin in the second round of the presidential elections of July 3,
1996. The latter vote was a pure choice for or against the communist 'restoration' (symbol-
ized by Communist candidate Gennadiy Zyuganov), while the former was for or against the
start of radical political and economic reforms15.
Table 3.3 presents a summary of the most important regressions obtained from testing
political variables. All the tested dependent variables (illustrating progress in economic devel-
opment) were positively correlated with electoral support for the pro-reform parties and
negatively with support for anti-reform parties.
15 Other candidates in June 1991 presidential elections included: former Soviet Prime Minister Nikolai Ryzhkov, opposing mar-
ket reforms, former Soviet Minister of Interior Vadim Bakatin, a symbol of gradual reforms, and Albert Makashov, a symbol of hard-
line communism and nationalist xenophobia.
36
3.4.2. The significance of basic institutions and the pro-reform coalition for
the investment climate
The second relation tested can be presented as: Esm_business= E(Rf_pol; Rf_leg, Rf_enf, … )
- - -
sm_business is small business employment as an indicator of the investment climate,
where E
Rf_pol is political risks factors; Rf_leg is legal risks factors; Rf_enf is contract enforcement risk fac-
tors. A description of the variables is presented in Tables 3.4
Table 3.4. Interregional model: Description of variables
No. Variable Description
Dependent variables
1. SMBEMPL01 Average number of employment in small business in 2001
2. SmBempl_Dyn01 Dynamics of employment in small business, 1995 -2001, in %
3. FOR_DIRINV Foreign Direct Investments 1996 -1999
Independent variables
1. COURTDEFDM2 At least one law court sentence in the case of offence against personal
immunity and the right of judicial defense
2. SMIRAT99 Freedom of speech ranking for 1999
3. SMIRAT00 Freedom of speech ranking for 2000
4. opp_smi_loc Mass media (published or broadcasted in the region territory)
5. For_retrans Local mass media regularly re -broadcasting programs of foreign mass
media
6. Cap_net&forco Subsidiaries or correspondent networks of Moscow -based mass media
7. HROactCourt At least one case won in court by human rights organizations or with
their support, 2000
8. BARR99 Barriers to the movement of goods and services across Russia’s regions
in 1999
9. BARR01 Barriers to the movement of goods and services across Russia’s regions
in 2001
10. BANKR_EC The number of pending bankruptcy cases where external management
was introduced, 2000
11. El99right Electoral support for pro -reform parties, 1999
12. El99extrem Electoral support anti -reform parties, 1999
13. El99confrm Electoral support for non -communist conformists lists, 1999
14. Confl01 Conflict between executive and legislative branches of government in
region, and between region and municipalities
15. FIXPRICE Price control by regional normative act
16. SOGLPRIC Informal p rice control
17. RESTPRICE Regulation of trade margins, profit margins, etc.
Source: Mau et al. (2003a)
The regressions with statistically significant outcomes are presented in Table 3.5. The
number of pending bankruptcy cases where external management was introduced and
regional political conflicts proved non-significant. Barriers to the movement of goods and
services across Russia's regions was significant in 1999 but became insignificant in 2001. Price
37
regulation became less significant because of gradual progress in adjusting regional legislation
to federal regulations after 2000.
Table 3.5. Investment climate determinants: results of regression analysis
2
No. Dependent variables Independent variables R (adjusted R -square) t-statistics
1. SmBempl_Dyn 2.017+ 0.289
1.410.5*EL99RIGHT+ 3.513
2.053.0*COURTDEFDM2+ 1.531 *
5.9*SMIRAT00 2.076
2. SmBempl_Dyn 6020+ 0.156
1965* COURTDEFDM2+ 2.009
1211* HROactCourt 3.137
3. SMBEMPL01 -11.349+ 0.383
2.049*EL99RIGHT+ 3.158
86.7* SMIRAT00+ 3.239
22.019* COURTDEFDM2 2.542
4. SmBempl_Dyn 3750+ 0.435
170.3*EL99RIGHT 2.731
1322.2* OPPSMI + 3.243
1977.6* CapNet&For 4.498
5. SmBempl_Dyn 5441+ 0.464
1.158.5*OPPSMI+ 2.861
1.414.8*Cap Net&For+ 3.432
1.957.2*For_Retran 4.669
6. SMBEMPL01 -7148+ 0.308
22587*COURTDEFDM2+ 2.461
119.6*SMIRAT00 4.578
7. FOR_DIRINV 155+ 0.172
307.4*Dumm_Rent - 3.557
148.9*RestPrice -2.384
Source: Mau et al. (2003a).
The obtained results show the importance of both human rights and civic freedoms
(regressions 2, 5 and 6 in Table 3.5) and the pro-reformist coalition (regressions 3 and 4) for
the investment climate.
3.5. Buying votes and pro-reform coalitions
The authors of the very first IET research on electoral behavior (Gambaryan and Mau,
1997) pointed out the counter-productive (from the point of view of a pro-reform govern-
ment) practice of subsidizing southern pro-communist regions (the so-called 'Red Belt') out
of the federal budget. In fact, pro-reformist regions were punished for loyalty and anti-
reform regions enjoyed financial support. Federal transfers gave some additional tiny elec-
38
toral support in national republics. However, the ethnically Russian populated regions
demonstrated a negative correlation between net federal transfers and electoral support for
Boris Yeltsin (see Table 3.6).
The conclusion we can be drawn from Table 3.6 is quite clear: a better economic perfor-
mance of the region is reflected in higher tax revenues per capita collection by the federal bud-
get and higher pro-government electoral support. This phenomenon reflects the rationality of
the Russian electorate. However, funding disloyal voters was a clear mistake of the pro-reform
camp: a rational leader oriented toward re-election should support loyal and marginal regions.
In terms of social groups, the leaders of a pro-reform camp should try to redistribute budget
transfers from agriculture to coal mine reconstruction or closure, from Soviet-type farm
employees and managers to large city teachers, doctors, etc. In contrast, anti-reform coalition
leaders demonstrated high efficiency in using public money to consolidate their electorate16.
Table 3.6. Federal transfers and support for Yeltsin in the 1996 elections
Budget item Correlation for all regions but national republics
First round Second round
All direct federal expenditures in the regions - 0.077 0.074
per capita, 1995
Net federal transfers, 1995 -0.626 - 0.487
Federal budget tax revenues per capita, 1 995 0.687 0.603
Source: Gambaryan and Mau (1997).
Table 3.7: Federal transfers and support for the government, 1999 compared to 1995
2
No. Dependent variable & Independent variables T-statistics R adjusted
coefficients
1. ‘Unity’ 1999 compared with 0,276 * (1999 November & 2.415 0.139
“Our Home Russia” 1995 %; December transfers sum) -3.591
(Delta_Yed_ndr) -0,410 * (North Caucasian regions
Dummy)
2. Delta_Yed_ndr 0,322 * (1999 November & 2.91 0.167
December and 1 -st quart. 2000 -3.735
transfers sum); (vvp99_2_00sum)
-0,413* (North Caucasian regions
Dummy)
3. Unity 1999, % 0,246* vvp99_2_00sum 2.118 0.083
-0,309* (North Caucasian regions -2.669
Dummy)
Source: Mau et al. (2003b)
The above described practice of supporting hostile voters changed only at the end of
1999. In contrast to the years 1995-96, analysis of 1999 election data does not present a sta-
tistically significant negative relation between pro-government voting and transfers per capita
(see Table 3.7). To test this hypothesis we applied a modified dependent variable: the differ-
16 Some researchers (e.g. Popov, 2001; Delyagin, 2000) have claimed the opposite, but did not present satisfactory statistical
evidence supporting their point of view.

39
ence in election results between pro-government election lists 'Our Home Russia (Nash Dom
Rossiya)' in 1995 and 'Unity (Edinstvo)' in 1999. The amount of transfer disbursement in
November-December 1999 and January-March 2000 served as the independent variables17.
3.6. Some conclusions
The preceding analysis allows us to draw the following conclusions:

Firstly, high and firm electoral support for a pro-reformist coalition is a key condition for
successful transition to a market economy. Both the international and the regional models
have demonstrated the greatest importance of voting for pro-reform parties, the duration of
their control over legislative and executive branches of government, etc.
Secondly, the outcome of the first free election ('constituent' election) significantly deter-
mines subsequent electoral behavior; this outcome is somewhat independent of the initial
economic situation.
Thirdly, basic institutions of human rights (personal immunity, court guarantees against confis-
cation or arrest, freedom of press and religion, private property) can affect business risk evaluation
more significantly than taxation, entrepreneurial legislation, etc, especially for the small business
sector. This conclusion permits us to specify the set of institutions that are crucial for successful
reform. It also underlines the importance of political reforms for the success of economic reforms.
In countries and regions that have carried out a successful transition (illustrated in our
models by GDP dynamics or other income/wealth indicators) demand for classical institu-
tions of a society based on the rule of law proposed by pro-reform parties and leaders is sub-
stantially higher than in countries/regions that have failed to emerge from post-totalitarian
recession. They relate to such basic market/democratic institutions as civil liberties, proper-
ty rights protection and effective contract enforcement.
Fourthly, as income and consumption dynamics can affect electoral behavior, election
outcomes can be more or less influenced by a conscious redistributive policy. This means
that a political business cycle approach (see Nordhaus, 1975) is a reasonable way to organize
and support a pro-reformist coalition in transition societies. It also means that political com-
promises have clear limits in terms of their rationality. If reformers are forced to support
anti-reform constituencies (for any reason) it will only further deteriorate their position.
17 We could not use data for 1999 as a whole because the election block 'Unity' was formed just a few months before the
December 1999 Duma elections and first three quarters of 1999 were characterized by a high level of political instability and
uncertainty about the future political map of Russia. So we assumed that regional governors who supported 'Unity' had a choice:
either believe in the Kremlin's promises of future transfers and push local administration structures to support this list or join an
alternative 'list of governors' – 'Fatherland – All Russia (Otechestvo – Vsya Rossiya)' headed by ex-Prime-Minister Primakov and
Moscow mayor Luzhkov. Thus, November-December 1999 and Q1 2000 transfer data may relevant for our goal of testing the
ability of the federal government to build electoral support by means of fiscal redistribution to loyal governors.
40
4. External leveraging of Russia's
reforms: the role of the IMF, the
World Bank and the G7 countries
4.1. The overall picture
In the 1990s, financial flows into Russia can be divided into three periods in terms of their
size and source. In the first period, 1992-1993, external official assistance, mostly from G7 coun-
tries, official and private debt relief, including deferral or cancellation of arrears and to lesser
extent financing from the IMF dominated (see Table 4.1). The total net official financial assistance
in 1992-93 accounted for over 4% (nearly 8% if official debt relief is included) of Russia's GDP18.
During 1994-1996 the major role in conditional financing to Russia was played by inter-
national financial organizations (IFIs), mostly the IMF and World Bank. However, the size of
official government financing to Russia increased by half, mostly as a result of the German
contribution to the G7 financing. Finally, in 1997-98, progress in transition, together with
explicit or implicit official guarantees, attracted private capital inflows in the form both of
portfolio investment and foreign direct investment. Nevertheless, financing from G7 coun-
tries was similar to IMF or private flows. The crisis of 1998 and default on debts virtually halt-
ed the inflow of official and private financing to Russia.
During 1992-93, Russia received a total of approximately USD 62 billion of external
financing (Citrin and Lahiri, 1995, Table 1.8), during 1994-96 ca. USD 66 billion and during
1997-98 ca. USD 62 billion (Kapur and Mensbrugghe, 1997). About 51% in 1992-93, 58%
in 1994-96 and 18% in 1997-98 of total external financing took the form of rescheduling of
debt and arrears towards rest of the world. Official lending (apart from the IMF) and grants
accounted for an estimated 28% of total financing.
18
By historical comparison, the USD13 billion provided by the US to Western Europe in 1948-1951 under the Marshall Plan,
mostly in the form of foodstuffs and raw materials, of which a significant part was military surpluses or industrial inventories, was
equivalent to an annual average of 2.5% of European GDP. Indeed, Marshall Plan assistance was mainly on grant terms, while most
official financing to FSU consisted of loans.
41
With net disbursements of USD 22.1 billion Germany was the single largest contributor,
representing 12% of total external financing received by Russia in the period 1992-9819.
Germany was followed by the IMF, which contributed USD 14.5 billion (8% of total exter-
nal financing), and by the World Bank, with USD 6.5 billion (3.4% of total financing). The
United States took fourth place, with USD 4.4 billion, only 2.3% of total financing received
in the period of 1992-98. The peak of official government financing come over the first two
periods and amounted to 38% in 1992-1993 and 32% of total financing in 1994-1996. IFI
financing reached its highest level in the second and third periods, amounting to 14% of total
financing both in 1994-1996 and 1997-1998.
4.2. Some motivation of lending to Russia
Apart from the very political will to support Russia's transition to democracy and market
economy other additional circumstances encouraged Western creditor/donor interest in
providing financial aid to Russia and the Russian authorities' interest in resorting to this source
of support.
At the beginning of transition, Russia was the main creditor to most FSU countries and
extended trade credits to facilitate the maintenance of trade and production links. The threat
of collapse of the ruble area made G7 governments and IFI experts reluctant to accept any
radical disruption of payment mechanisms in the territory of the FSU, therefore accepting
both the financial costs borne by Russia in the early phase of transition and the financial impli-
cations for Western creditors. Analyses of Russia's public expenditure record indicate that
most spending, irrespective of how it was financed, was for current rather than capital pur-
poses, including the settlement of arrears on wages and pensions. As such, the governments
of G7 countries, facing an unprecedented political and economic challenge, agreed that "sav-
ing Russia from communism matters more than the niceties of monthly bookkeeping" (The
Economist, 1996) and accepted massive and unconditional financing of Russia's transition.
Later on, as a result of substantial and prolonged GDP decline (cumulatively of over 35%
in 1991-1994 and an additional 11% in 1995-1998), there was a sharp fall in government rev-
enues that, combined with pressure to maintain spending levels, resulted in very high gen-
eral government deficits of over 18% of GDP in 1992, 7.4% of GDP in 1993 and 10.4% of
GDP in 1994. The usual response of governments in the early years of transition was to
finance budget deficits by central bank credits, but the experience of hyperinflation or high
and persistent inflation, combined with an abundance of external financing, persuaded the
authorities to rely on foreign assistance and domestic non-monetary financing.
19 A significant part of German aid was connected with the redeployment of Russian troops stationing on the territory of the
former GDR.
42
4. External leveraging of Russia's reforms: the role of the IMF, the World Bank and the G7 countries
Official external assistance and borrowing abroad appeared cheaper in the short term
than borrowing from domestic financial markets, and longer maturities have been available
on foreign loans. The financial needs of Russian governments have been matched by the will-
ingness of both the IFIs and private companies to lend, at least until the last quarter of 1997.
On the creditor side, the initial perception was that Russia had lower external indebtedness
than most developing and transition economies (slightly over 22% in 1996). More impor-
tantly, substantial margins could be achieved on Russian Treasury papers relative to tradi-
tional sovereign borrowers, while medium-term bond yields in many traditional markets
have either stabilized at relatively low levels or fell in the mid-1990s.
4.3. The role of the IMF
The IMF was the most important IFI in the first stage of the transition (Dabrowski, 1998;
Gomulka, 1995) acting on behalf of the donor countries, particularly those belonging to the
G7. This can be explained by the organization's significant experience not only in macroeco-
nomic policy but also in structural and institutional reforms. IMF support to Russia started
with the Stand-By Agreement (SBA) in June 1992, followed by two Structural Transformation
Facility (STF) tranches (see Table 4.2).
Table 4.2. IMF facilities for Russia, 1992-2000
Year 1992 1993 1994 1995 1996 1997 1998 1999 2000
Type of program SBA STF STF SBA EFF SBA
Sources: www.imf.org.
The first 1992 SBA did not involve strict conditionality. The same went for the STF, which
was a financing facility of limited size specially designed for transition economies under
severe trade and payment disruptions (between 1993 and 1995). Performance criteria were
loose, with fiscal deficits of up to 10% of GDP permitted (Dabrowski, 1998).
On June 30, 1993, the IMF Executive Board approved an economic program to be sup-
ported by a two-tranche purchase under the STF. Russia purchased the first tranche of SDR
1,078.3 million (equivalents to 25% of the quota) from the IMF on July 6, 1993. The STF, as
a brand-new IMF facility, made it possible to credit the new Russian government irrespective
of the failure of the SBA in 1992. Also, the STF purchase from the IMF would not have to be
added to the stock of Russia's official international reserves but would be available to provide
additional credit to the economy (and to the budget). The program got off to a good start,
but as early as the third and the fourth quarters of 1993 targets were exceeded by wide mar-
gins (Figure 4.1) However, this did not result in a halt in the funding (see Figure 4.2).
43
Figure 4.1. Russia's compliance with IMF quantitative monetary, fiscal, and exchange rate targets in
1993-1999 (in %)
10 0 80 0
75 60 0
50 40 0
25 20 0
0 0
%
%
-25 -200
-50 -400
-75 -600
-100 -800
June -9 4
June -9 3
December-9 3
December-9 4
September-9 6
September-9 7
September-9 8
Septembe r-9 5
September-9 9
Ma rch- 96
Ma rch- 97
March- 98
March-99
Monetary (LHS) Fiscal (LHS) Forex reserves (R HS )
Note: Exceeding targets should be viewed as non-compliance with conditionality. Targets are equally weighted.
Source: IMF (A4C, IFS, RED, SP).
On April 20, 1994, the second STF tranche of SDR 1,078.3 million was approved. The major
goal of the program was to safeguard the fragile achievements of the hitherto reforms, especially
in the areas of price and exchange rate liberalization, and foster structural reforms, including
mass privatization, foreign trade liberalization, increased competition and transparency.
In the second quarter of 1994 program implementation was on target. The monthly infla-
tion rate fell to 6% in June and to 4.5% in August 1994. The government managed to keep
its borrowing from the CBR within the program targets, though mainly through aggressive
sequestration of expenditures as budget revenues collapsed. In the third quarter, however,
CBR credit surged as revenues fell in relation to GDP and subsidies to the agricultural sector,
the Northern Territories and other customary recipients of budget support rose sharply. The
government's ability to use sequestration diminished and parliament rejected most of the rev-
enue measures specified in the second STF. In mid-1994, the authorities ran down official
reserves in an attempt to offset increasing net credit to the government. After international
reserves dropped by almost USD 4 billion in the third quarter of 1994, foreign exchange mar-
ket participants started to speculate against the ruble. On October 11, 1994 ('Black Tuesday'),
the ruble tumbled on the Moscow inter-bank market by over 20% against the USD.
In the fourth quarter of 1994, the central bank limited credit expansion to banks and the
government and Ministry of Finance restricted expenditures and started issuing government
securities. The credit contraction led to a rise in interest rates, but inflation continued to
increase, reaching a monthly rate of 16% in December 1994 – twice the STF projection.
Fiscal targets were exceeded by wide margins, the stock of international reserves dropped
44
Figure 4.2. IMF net disbursements to Russia in 1992-2001 (millions of USD)
4,000 16,000
Net flows (LHS)
3,500 14,000
Net cumulative flow (RHS)
3,000 12,000
2,500 10,000
millions of US$
millions of US$
2,000 8,000
1,500 6,000
1,000 4,000
500 2,000
0 0
April- 97
September- 96
March- 93
March- 00
De ce mber -94
November -97
October- 93
October- 00
August -92
August-99
Fe bruary -9 6
June -98
Ma y- 94
July -95
January- 92
January- 99
-500 -2,0 00
Source: www.imf.org
below the target, the exchange rate depreciated by 45% during the second half of 1994 and
the majority of liberalization measures were not implemented. The second STF had failed as
completely as its predecessor.
As in previous years, a major tightening of monetary and fiscal policies took place at the
beginning of 1995. In January, the stock of credit to the government was frozen, the CBR
increased reserve requirements, and – as international reserves kept declining – the mone-
tary base shrank by 9%. Inflation slowed to 10-11% in February-March. On March 10, 1995,
in a letter to the IMF's Managing Director Michel Camdessus, President Boris Yeltsin
expressed his support for the new program. On April 11, 1995, the IMF Executive Board
approved the SBA support of SDR 4,313.1 million for a period of 12 months. According to
official statements, the SBA was aimed at decisive progress in stabilization and structural
reform during 1995 and envisaged the same measures as in the previous programs, both
from the macroeconomic and structural perspectives.
In the course of the SBA quantitative targets were all met month by month by comfort-
able margins. The most vulnerable situation remained in the fiscal sector because of the sub-
stantial revenue shortfalls that persisted throughout 1995. Measures to improve revenues
were implemented only partially or with a lag. The main revenue categories barely exceed-
ed the program's projections in nominal terms in spite of substantially higher inflation, and
for 1995 the ratio of revenue to GDP turned out to be nearly 3 percentage points below the
programmed level. Under these circumstances, in order to meet the deficit target, the
authorities contained spending (in relation to GDP), keeping it below programmed levels.
On the monetary side, while domestic credit targets were met, large capital inflows put
pressure on the ruble, leading to nominal and real appreciation and/or growth in the mone-
45
tary base (given the limited capacity for sterilization). Growing confidence in the ruble and
an increase in reserves made possible the introduction of an exchange rate band on July 5,
1995 (4,300 – 4,900 rubles per 1 USD). However, in the second half of October, pre-elec-
tion pressure became evident and fiscal policy started to drift away from the targets. The
previously accumulated margins allowed the targets for October and November to be met.
In December (especially in the last ten days of the month), the authorities probably used
'window dressing' to meet the targets.
Structural reforms, especially bank restructuring, were relatively sluggish. This became
evident when an inter-bank liquidity crisis emerged toward the end of August 1995. The pace
and scale of cash privatization fell short of expectations and the transparency of the whole
process, due to the introduction of the 'loans-for-shares' scheme, was thrown into doubt.
Finally, little progress was achieved in the area of land reform. Summing up, in 1995 the
Russian authorities apparently decided to meet the macroeconomic targets but at expense of
structural reforms that conflicted with the interests of various lobbies and were therefore
politically difficult. The relative success of the 1995 SBA (in comparison with the performance
of the previous arrangements) allowed the Russian authorities to request IMF support for the
medium-term program of macroeconomic stabilization and structural reform.
In a letter dated March 6, 1996, the Russian government requested a three-year arrange-
ment under the EFF to the tune of SDR 6,901 million, or 160% of the quota. The on-going
stand-by program would then have to be cancelled as of the date of approval of the extend-
ed arrangement. This trade-off yielded positive results: almost immediately, on March 26,
1996, the IMF Board approved the program.
The proposed strategy for 1996-1998 was aimed at establishing a foundation for sustain-
able growth by lowering inflation to a single-digit annual rate, implementing key structural
reforms and achieving medium-term viability of the balance of payments. The 1996 program
was based on reasonably optimistic forecasts, such as a high annual rate of GDP growth (6%
starting from 1997), 1% monthly inflation as of the end of 1996, remonetization, repatriation
of flight capital, an increase in FDI and a comprehensive restructuring of debt obligations (USD
7 billion). The huge debt service burden of the federal budget had already been seen in 1996.
However, a further reduction in a general government deficit from around 6% of GDP
in 1995 to 4% of GDP in 1996 and 2% of GDP in 1998 was the critical element of the pro-
gram. Local governments and off-budget funds were to balance their budgets or finance
deficits from non-inflationary sources (without credits from the CBR). The net increase in
revenues of close to 5 percentage points of GDP was to result from an increase in tax rates
and a broadening of the tax base via the elimination of tax exemptions and preferential treat-
ment, especially for fuel producers.
The monetary framework targeted the same parameters as previous programs, limiting
the pace of credit expansion and monetization of the budget deficit. The programmed
46
domestic assets expansion would not result in growth of the monetary base because it was
exactly offset by a decline in the monetary authorities' net international reserves. The same
was true of the 1995 program – the sale or use of central bank foreign reserves was includ-
ed as part of the monetary authorities' net credit to the federal and general governments.
Therefore, the IMF's intention was clearly non-inflationary deficit financing.
The period 1996-1998 reflected a fragile and illusory macroeconomic stabilization. Since 1995
Russia had not been able to achieve its main fiscal policy objectives, which were a reduction in the
unsustainably high deficit, a reversal in declining budget revenues and a reduction of expenditures.
The general government primary deficit rose from 2.6% of GDP in 1995 to 3.1% of GDP in 1997
and the overall deficit increased from 6.1% to 7.7% of GDP in the same period. At the same
time, general government revenues increased from 33.5% of GDP in 1995 to 35.5% of GDP in
1997 only, whereas expenditures increased from 39.6% to 43.2% of GDP in the same period.
This reflected a number of fundamental factors but perhaps the most important among them was
a continued recourse to non-monetary fiscal operations and tax offset schemes on the revenue
side and expansion of interest payments on debt on the expenditure side.
In mid-1998, the accumulation of macro- and microeconomic problems coincided with
cumulating maturity of debt payments due in the third quarter of 1998, amounting to one
third of budget revenues and a current account deficit resulting from a decline in world oil
prices. Moreover, the Asian crisis in 1997-1998 had increased financial market volatility and
investor pessimism about the performance of the Russian economy.
Some adjustment measures proposed by the government of Prime Minister Sergei
Kiriyenko, especially sequestration of expenditures and proposed changes in tax law, did not
find support in the Duma. Capital flows remained volatile and market confidence was not
restored. On July 16, 1998, a Memorandum on Economic and Financial Stabilization Policies
was signed between the Russian authorities and the IMF. The government program was basi-
cally identical to those supported by the IMF but which had not been implemented over the
previous five years. It aimed at radically tightening the federal budget and lengthening debt
maturity. The authorities expected 'substantial foreign financing' of the program.
The proposed package of measures for 1998 was partially based on the on-going EFF
arrangement. However, the Duma rejected the proposed changes in tax policy (broadening
the base of Personal Income Tax and transferring a higher share of PIT revenues to the fed-
eral budget, increasing the land tax and balancing the budget of the Pension Fund). The
Russian government had to provide a supplementary memorandum to the IMF on July 20.
On July 31, the IMF tried to avert crisis by disbursing a SDR 3.4 billion tranche. However,
this in fact only hastened the inevitable deep correction of the exchange rate which had been
made necessary by accumulated macroeconomic imbalances.
With the crisis of August 1998, Russia breached all quantitative targets established in the
EFF program. IMF disbursements to Russia came to a halt. The next program, the SBA for
47
SDR 3.3 billion (55.5% of quota) for a period of 17 months, was signed on July 28, 1999.
Through the end of 2000 Russia made only one purchase. Quantitative performance criteria
for the end of July, the end of September and the end of December 1999 were reached
(many with large margins). However, there were also many shortfalls relative to structural
benchmarks for the third and fourth quarters of 1999.
As IMF disbursements in the first-generation programs (i.e. STF and SBA) may have been
attributable to soft conditionality and the political commitments of G-7 governments, the
failure of the second-generation programs (EFF) was proof of a certain myopia in the Fund's
approach that perceived short-term macroeconomic stabilization as a sign of its long-term
sustainability. If the Russian authorities were prepared to follow the path of responsible poli-
cies, external binding commitments could give them an additional political instrument.
However, there were four main group of factors that determined the failure of the IMF sta-
bilization policy in Russia: (1) Unrealistic assumptions concerning GDP growth, exports, and
budget revenues led to formulation of stabilization programs that were sustainable only if
these assumptions were realized. (2) Lax conditionality undermined macroeconomic disci-
pline, while (3) improved access to non-inflationary sources of deficit financing was a source
of accumulation of arrears and debt. Finally, (4) ineffective conditionality in the area of struc-
tural reforms stimulated only 'paper reforms' and not real restructuring of the economy (see
Antczak, Markiewicz, and Radziwill, 2003).
4.4. The role of the World Bank
The World Bank's goal in Russia was to ease the structural transition from a planned to a
market economy, avoid the geopolitical consequences of a policy reversal and minimize the
human costs of the reforms (Zanini et al., 2002, p.37). In practice, the Bank's objectives were
defined as: (1) restructuring of old enterprises, (2) the creation of new enterprises, (3) an
Table 4.3. World Bank lending to Russia, 1992-2002 (millions of USD)
a
Fiscal Year 1992-95 1996 1997 1998 1999 2000 2001 Cancelled Total
Rehabilitation loans 1 200 0 0 0 0 0 0 0 1 200
SALs (SECAL&SPAL) 0 500 1 400 1 600 1 500 0 0 1 100 3 900
Oil, gas, and energy 1 180 528 40 0 0 0 85 352 981
Social sectors 110 470 137 29 0 0 130 120 755
PSD/FSD/infrastructure 1 519 763 216 0 400 0 182 1 069 2 012
Agriculture/environment 529 80 0 0 0 60 226 118 777
Econ. public sector mgt 70 21 58 0 30 30 0 2 195
TOTAL 4 608 1 899 1 816 1 629 1 930 90 624 2 761 9 834
Disbursements 729 981 2 086 2 172 657 606 605 7 836
Note: a – fiscal year starts from July 1 of the previous calendar year
Source: Zanini et al. (2002), p. 41.
48
improved environment for investment and (4) reform of social protection. Average annual
disbursements amounted to around USD 600 million from over USD 1 billion annual com-
mitments to Russia during 1992-1998 (see Table 4.3).
World Bank aid focused mostly on structural projects which needed time to be prepared
and implemented. This was the reason why during the first period of Russia's reforms in
1992-1993 only 4 projects were launched. However, in August 1992, at the request of the
G7, and in parallel with the IMF, the SBA the World Bank approved USD 600 million of the
Rehabilitation I Loan with virtually no conditionality. The Rehabilitation II Loan was post-
poned until mid-1995 by which time various trade reforms had been adopted and the IMF
accepted the SBA for Russia (see Section 4.3).
A rapid expansion of lending took place during the years 1994-1996, with 24 projects
launched and the Bank's commitments reaching over USD 1.5 billion annually. According to
the assessment of the Operation Evaluation Department of the World Bank, over 60% of
project commitments experienced serious implementation problems (see Zanini et al., 2002
for details) and from mid-1995 to early-1996 less than USD 30 million of new commitments
were made by the Bank. In March 1996, the Bank came under pressure to join the IMF,
which had approved the USD 10.1 billion EFF (see Section 4.3). This was clearly a manifes-
tation of donors' desire of 'avoiding the geopolitical consequences of a policy reversal' four
months before the July 1996 Presidential elections. Irrespective of technical difficulties, the
Bank was able to move with investment and technical assistance programs worth USD 1.9
billion and targeted towards housing, capital markets development, legal reform, medical
equipment, and coal sector adjustment.
The peak of the Bank's commitments came in the calendar year 1997, with projects
amounting to USD 3.4 billion followed by peak disbursement of USD 2.2 billion in 1998 (see
Table 4.3). The formation of the government of 'young reformers' (see Chapter 2) was seen
as a window of opportunity for structural reforms. Adjustment lending amounted to USD 3
billion and involved Structural Adjustment Loans I and II (with conditionality related, among
other things, to tax reform, elimination of budget arrears, case-by-case privatizations,
restructuring of power, natural gas, and railways sectors and banking reform), the Social
Protection Adjustment Loan and the Coal Sector Adjustment Loan (SECAL II).
The loan conditions were mild and mostly related to preparatory reform steps such as
drafting or submission of legislation to the Duma rather than adoption of legislation, its
enforcement and implementation. Furthermore, most were not really fulfilled. However,
both the IMF and World bank granted Russia a not fully justified 'seal of good housekeeping'
that opened the door to bilateral donor and private financing. This stamp of approval led to
upgrading Russia's international ratings and very significant capital inflows.
After the appointment of the Kiriyenko government in April 1998 the World Bank and
IMF were called on by the G7 to contribute around USD 6 billion to the emergency financial
49
package aimed at strengthening confidence in the ruble. The Bank responded by accelerat-
ing the processing of the USD 1.5 billion SAL III. However, its disbursement was limited to
the first tranche of USD 300 million in July 1998 and one small tranche of USD 100 million
in mid-1999, following the loan's restructuring. The 1998 crisis adversely affected many of
the Bank's projects and led to halt in substantial financing. During 1999-2000, the Bank
focused on social protection, education, health care and municipal programs.
4.5. The role of the G7
The interest of the major industrial democracies in supporting the political and econom-
ic transition in the former Soviet Union started from the 1990 Houston Summit, where the
Group of Seven (G-7) leaders ordered a joint OECD/IMF/World Bank/EBRD 'Study of the
Soviet Economy', which was published a year later. Beyond the very general G7 commit-
ments to the Soviet Union and Russia at Houston (see Table 4.4), German Chancellor
Helmut Kohl for the first time called for Soviet support to the unification of Germany. The
French President Francois Mitterrand joined Kohl in calling for USD 15 billion in outright
grants and loans to the Soviet Union, but other leaders disagreed. At first, President George
Bush dismissed the idea of giving assistance to the Soviet Union, then eventually joined the
position of UK Prime Minister Margaret Thatcher who insisted the aid be conditional on eco-
nomic and political reform.
Table 4.4. The G-7 commitments to Russia
Commitments
Year and place of summit Total number of on Russia or related to Russia
Commitments G7 / G8 Political Sum /
Communiqué Declarations % of total
1990, Houston, U.S 78 3 1 4 / 5%
1991, London, UK 53 1 1 / 2%
1992, Munich, Germany 41 12 6 18 / 44%
1993, Tokyo, Japan 29 8 8 / 28%
1994, Naples, Italy 53 3 1 4 / 8%
1995, Halifax Canada 78 1 1 / 1%
1996, Lyon, France 128 3 3 / 2%
1997, Denver, U.S. 145 6/2 8 / 6%
1998, Birmingham, UK 73 0 / 0%
1999, Köln, Germany 46 0 / 0%
2000, Okinawa, Japan 105 0 / 0%
2001, Genoa, Italy 58 0 / 0%
2002, Kananaskis, Canada 187 0/6 6 / 3%
Note: The commitments identified are taken from all documents issued publicly by the G7/8 at its annual summits, from 1990
to 2002. These documents include summit communiqués, statements from the chair and political, economic and miscellaneous
declarations by the G7/8. They exclude reports to the summit leaders or documents issued at the summit by other G8 groups
or larger dialogue groups.
Source: Kirton et al. (2003).
50
During the 1991 London Summit the Soviet President Mikhail Gorbachev was invited to
have a lunch with G-7 leaders. The G7 and US President George Bush proposed the Soviet
Union become 'a special associate' of the IMF and the World Bank. In addition, the Soviet
Union would get agricultural credit guarantees of USD 1.5 billion.
Developments in the former Soviet Union at the end of 1991 and early 1992 were beyond
the G7's expectations. Therefore, the Munich Summit in 1992 was dominated by problems
created by the collapse of USSR and over 44% of all commitments were related directly or
indirectly to Russia. Attention was mainly focused on preventing the transfer of scientists and
proliferation of nuclear capacities from the former Soviet Union to other countries and the
G7 made its first offer to FSU countries, including Russia, to finance guaranteeing the safety of
their nuclear programs. The G7 proposed USD 24 billion of financial aid for Russia, from
which USD 6 billion was to be set aside to stabilize the Russian ruble (following the positive
example of USD 1-billion stabilization fund established for the Polish zloty in January 1990),
while USD 18 billion was earmarked for economic restructuring. Most of the declared aid was
never concretely committed and disbursed. In June 1992 the Russian Federation joined the
IMF and the World Bank, resulting in the SBA and Rehabilitation Loan (see Section 4.3).
The summit in Tokyo in 1993 added some aid declarations. G7 conditionality did not go
beyond those of the IMF and World Bank and insisted on control of Russia's budget deficit
and money supply. Prices, including energy prices, also had to be fully freed. There also had
to be firmer guarantees for private property rights, while all republics of the former Soviet
Union had to show leadership in dismantling trade barriers between one another. The same
kind of recommendations and conditionality were given by the IMF under the STF programs.
During the 1994 summit in Naples the G-7 offered Russia the perspective of GATT mem-
bership. During the next summit in Halifax the issues of dismantling nuclear weapons that
had been initiated under START I and ensuring control over fissile material from nuclear
weapons and reactors were the main topics raised by the US and other G7 countries. The
G7 also insisted on nuclear disarmament and safety in Russia at the Lyon Summit in 1996.
In 1997, at the Denver Summit Russia was granted non-full member status and effective-
ly the G7 became the G8 at the subsequent two summits. Russia's membership of the G8
was strongly advocated by US President Bill Clinton as compensation for NATO's expansion
eastward and also as a final legalization of its discretional presence at G7 summits since 1991.
After the Denver Summit, the goal of bringing Russia into international organizations such as
the Paris Club, WTO and OECD was also expressed by the G7, together with its strong
insistence on Russia's active participation in nuclear safety and security programs.
The 1998 financial crisis in Russia came as an unexpected and unpleasant surprise for the
G7, given its deep engagement in preventing such a course of events. During 1997-1998 total
external financing to Russia amounted to USD 61.7 billion, a level similar to 1992-1993, and
relatively higher than during 1994-1996. The G7 made over 90% (USD 6.5 billion) of bilat-
51
eral official financing, with Germany's contribution amounting to 80% (USD 5.2 billion) of the
overall G7 share (see Table 4.5). IMF and the World Bank financing was USD 8.9 billion com-
bined. FDIs and other (short term financial) investments, as well as debt relief, reached a
record high of USD 42.7 billion.
Overall during the period 1992-1998 Russia received USD 189,250 million in total financ-
ing, of which USD 41,507 million (22% of total financing) was in bilateral official assistance,
with USD 31,978 million (17% of total) coming from the G7 and Germany as the largest con-
tributor with over USD 22 billion (12% of the total). The IMF and the World Bank combined
contributed USD 20,930 million (over 11% of the total). Investments to Russia, direct and
portfolio, both reached over USD 15 billion in 1992-1998.
However, the largest financing resulted from debt relief and arrears towards ROW to the
sum of USD 81,500 million (43% of total financing). The exact disaggregation of this item
between debt relief and arrears of sovereign governments and public and private companies
is difficult due to the lack of reliable data and low transparency of bilateral and multilateral
deals. One can assume that the G7 contributed to the lion's share of it.
Table 4.1. Gross financial flows into Russia, 1992-1998 (millions of USD)
Loans Debt relief Debt FSU
Years Official Arrear relief financin Total
4
EU EBRD IBRD IMF ROW1 Grants Private 2 Official 3 s ROW &arrears FDI Other 5 g financing
1992-3 341 100 400 2 541 17 900 5 800 11 500 14 000 6 000 31 500 2 200 500 300 61 582
1994-6 154 747 2 203 6 901 16 428 4 586 - - - 39 000 5 334 -9 448 - 65 905
1997-8 245 936 3 851 5 034 7 179 1 790 - - - 11 000 7 628 24 100 - 61 763
Total 740 1 783 6 454 14 476 41 507 12 176 11 500 14 000 6 000 81 500 15 162 15 152 300 189 250
Notes: 1 ROW includes all countries other than FSU countries.
2 Private debt relief includes deferrals and rescheduling by suppliers.
3 Official debt relief includes Paris Club rescheduling, deferrals, and rescheduling by other creditors including Kuwait and Saudi Arabia
4 Debt relief & arrears sums up debt relief and arrears
5 Other financing is composed of private short-term capital flows
Source: OECD MAXDATA Statistical Compendium 1#2003; IFS IMF April 2003; IMF Country Reports.
Table 4.5. Gross official flows from the G7 into Russia, 1992-1998 (in USD millions
and as a % of total financing)
Total United United
Germany Italy Japan Canada France
Years financing States Kingdom
Mln Mln % Mln % Mln % Mln % Mln % Mln % Mln %
1992-1993 9 565 6 539 10.6 1 931 3.1 151 0.2 173 0.3 681 1.1 72 0.1 18 0.03
1994-1996 15 882 10 360 15.7 1 730 2.6 3 089 4.7 427 0.6 81 0.1 142 0.2 53 0.1
1997-1998 6 530 5 164 8.4 697 1.1 26 0.0 382 0.6 50 0.1 111 0.2 100 0.2
1992-1998 31 978 22 063 11.7 4 358 2.3 3 267 1.7 982 0.5 812 0.4 325 0.2 171 0.1
Source: OECD MAXDATA Statistical Compendium 1#2003
52
5. The Effects of Economic Reform
in Russia
The aim of this chapter is to illustrate the outcomes of economic reforms in Russia with
the help of statistical (quantitative) indices and qualitative (characterizing institutional
changes) policy indicators, as well as to compare them with other transition countries. As
shown in Chapter 2, the implementation of all the principal ingredients in the transition
process, such as liberalization, macroeconomic stabilization, restructuring and privatization,
legal and institutional reforms (see Fischer and Gelb, 1991), has been characterized by a
great deal of inconsistency, which has in turn been one of the main reasons behind the slow
pace of reform and its often contradictory results.
Thus, the claim that all socio-economic indicators at every stage of the transition process
have evolved under the direct influence of the reforms per se would be incorrect. Instead,
one can speak about the resultant vector of many unfinished and inconsistent (compared e.g.
to the CEB countries) components of the reforms and the effects of many exogenous and
endogenous factors.
We have chosen 1989-90, 1994-95, 1998-99 and 2002-2003 as the breaking points for our
comparisons as they reflect periodization of the Russian reforms presented in Chapter 220.
5.1. Macroeconomic developments
The transition period began with two great shocks: an output fall (see Figure 5.1) and a
burst in inflation (see Figure 5.2).
According to Gaidar (1997; 2003a; 2003b), the major factors that determined the length
and depth of the 'adaptation' output decline in Russia in 1990s (as distinct from many CEB
countries) were: (i) a large share of production, which did not meet real market demand (but
20 Earlier comparative data, for example, for 1984 or 1985 illustrating the pre-Perestroika state of affairs are not available.
Late-Soviet data (1989-1990) are also not always comparable with the later ones or their quality is doubtful. This is a standard
problem in investigating growth trends in post-communist economies.
53
Figure 5.1. GDP (constant 1995 USD), annual % change

20
10
0 Czech Republic
Estonia
Georgia
-10
Hungary
Kazakhstan
-20
Poland
Romania
-30 Russian Federation
Ukraine
-40
Source: World Development
Indicators Datablase, IMF WEO
-50 2003
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
instead was determined by a centralized state planning system, primarily in military-industri-

al complex); (ii) minimal use of market instruments under a communist regime; (iii) a com-
plete loss of skills to work under market conditions.
Figure 5.2. Inflation, consumer prices (annual %)
100000
10000
Czech Republic
Estonia
1000
Georgia
Hungary
%
100 Kazakhstan
Poland
10 Romania
Russian Federation
Ukraine
1
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: World Bank World Development Indicators Database,
IMF World Economic Outlook Database, IMF WEO 2003.
0.1
Apart from these unfavorable starting conditions, development trends throughout this
period were determined by the slow pace and non-optimal sequencing of the reforms them-
selves. Slow pace and inconsistency of macroeconomic stabilization and fiscal adjustment
hampered structural and institutional changes, which in turn prolonged the period of deep
output decline in Russia (the over 40% output fall lasted for 8 years!). Positive growth
54
5. The Effects of Economic Reform in Russia
dynamics, accompanied by macroeconomic stabilization, did not start until 1997 and in 1998
Russia was again thrown into financial crisis.
As opposed to Russia, comprehensive and consistent reforms in CEB countries have
allowed the duration of 'adaptation' output decline to be reduced, although in some it still
appeared to be rather deep (for example in the Baltic countries). However, one should keep
in mind all the methodological risks involved in cross-country comparative analyzes of
growth records21.
Comparisons with other countries show that progress in macroeconomic stabilization
(especially lowering inflation) became a key basis for any subsequent output recovery.
Countries that managed to tame inflation quickly tended to experience a speedier and
stronger recovery in output (see e.g. IMF, 2000). Moreover, in many CEB countries the early
success of economic stabilization helped strengthen the constituency in favor of further
reforms, both political and economic. In Russia, though, economic growth was delayed and
the country has found itself in slow reform equilibrium mode for several years now.
High growth rates in Russia starting from 2000 can be explained by: (1) the depth of the
previous output decline and use of simple reserves (e.g., utilization of idle capacities); (2) the
positive effects of economic reforms conducted in the 1990s (particularly privatization), and
(3) high oil prices on international markets (see Dabrowski, 2003).
Further economic growth will be determined, however, by more sophisticated factors,
including investment dynamics. In Russia, the average annual growth rate of gross domestic
investment during 1991-2001 was negative, amounting to -14.6%. The situation changed
Figure 5.3. Volume indices of investments in fixed capital in Russia (1990=100)
60
50
40
% 30
20
10
Source: Goskomstat
0
1992 1993 1999 1995 1996 1997 1998 1999 2000 2001 2002
Total investments in fixed capital Investments in fixed capital in industry Investments in fixed capital in services
21 Some problems with the pre-transition GDP statistics (for example, low utility and quality of final output, limited consumer
choice, distorted prices and exchange rates, over-reporting of output under the communist regime) were far more severe in the
former Soviet Union than in some Central European countries.
55
only in 1999 and positive growth rates were achieved in 2000-01 (+18.6% and +17.0%,
respectively – see Figure 5.3).
Table 5.1. FDI in transition countries, 2002 (cumulative, USD M)
Country/ Region Total, USD M Per capita (USD )
Czech Republic 37 000 3 603
Slovakia 10 000 1 859
Hungary 27 000 2 659
Poland 46 000 1 191
Slovenia 5 500 2 754
Central Europe 125 500 1 890
Bulgaria 4 400 564
Romania 8 600 383
Croatia 7 700 1 738
South-East Europe 24 900 476
Estonia 3 600 2 647
Latvia 3 000 1 282
Lithuania 3 600 1 040
Baltic countries 10 200 1 425
Russia 25 000 174
Ukraine 5 000 104
Belarus 1 400 140
Moldova 700 193
European CIS 32 100 156
Source: WIIW-WIFO Database.
As distinct from CEB countries, which solved the problem of the domestic savings deficit
by attracting FDI, Russia has a far from impressive record in this sphere (see Table 5.1) most-
ly due to its poor investment climate. Moreover, in all the transition periods Russia suffered
substantial capital outflows (see e.g. Loungani and Mauro, 2000; Buiter and Szegvari, 2002).
In spite of progress made in fighting inflation its rate has remained higher compared not
only to industrially developed economies, but to other transition economies as well. Among
the latter, Russia ranked 22nd in 2001, ahead of only Belarus, Romania and Uzbekistan.
Up to 1999 fiscal policy (see Figure 2.1 in Chapter 2) could be blamed as the key factor
responsible for the failure to bring inflation down to a low, i.e. single-digit, level. In 2000-03,
as the fiscal situation radically improved inflationary pressures started to be generated from
the huge balance of payments surplus and rapid increase in the CBR's foreign assets
(Dabrowski, Paczynski and Rawdanowicz, 2002). In 2000, CBR gross foreign exchange
reserves increased to USD 19.1 billion (from USD 9.4 billion in 1999), while the monetary
base grew 1.5-fold. By mid-2003, foreign exchange reserves had grown to USD 64.9 billion
(see Figure 5.4).
56
Figure 5.4. The CBR's gold and foreign exchange reserves, 1997-2003 (million USD)
70 000
Source: CBR
60 000
50 000
40 000
30 000
20 000
10 000
0
01-05-98
01-05-99
01-05-00
01-09-00
01-09-03
01-09-98
01-09-99
01-09-01
01-01-99
01-01-01
01-01-97
01-01-98
01-01-00
01-05-01
01-05-02
01-05-97
01-09-02
01-09-97
01-01-02
01-05-03
01-01-03
Gold Foreign exchange
Source: Central Bank of Russia www.cbr.ru;
The level of monetization has also remained low throughout the transition period, reach-
ing 20% of GDP only by the end of 2001 (see Figure 5.5 for comparison with other countries).
Generally, developments in monetary and fiscal policy spheres gave a picture of delayed
stabilization in Russia and reminded developments in Latin America after the World War II
(Gaidar et al., 1998, Chapter 6, p. 242). The lack of sufficient macroeconomic stability had
also its unfavorable microeconomic equivalent: soft budget constraints, budget, tax, wage
and pension arrears, netting-out operations, proliferation of money surrogates, widespread
barter practices, dollarization, and expansion of unregistered economy. According to esti-
mates of Johnson, Kaufmann and Shleifer (1997), unofficial economy represented 42% of
GDP in Russia, 49% in Ukraine, and over 60% in Azerbaijan and Georgia in 1995.
Figure 5.5. Money and quasi money (M2) as a % of GDP
80
Source: World Development
Indicators Database
70
Czech Republic
60
Estonia
50 Georgia
Hungary
40
Kazakhstan
30 Poland
Romania
20
Russian Federation
10 Ukraine
0
1990 1991 1992 1993 1994
9
94 1995 1996 1997 1998 1999 2000 2001
57
After the 1998 crisis, however, the scale of these phenomena decreased. The total vol-
ume of overdue arrears declined from 53.2% of GDP in 1997 to 48.6% of GDP in 1998 and
18.8% of GDP in 2000. The volume of barter transactions and mutual clearing shrank from
64.7% of total sales in 1998 to 36.8% in 2000 (Yasin, 2003, p. 295). According to 'Russian
Economic Barometer' estimates, by October 2001 barter volume had decreased to 13% of
total sales.
5.2. Structural changes in the economy
Industry was the major 'losing' sector during the 'adaptation' output decline period, with
a cumulative fall of ca. 60% (this was in large measure the consequence of the over-indus-
trialization of the Soviet period). In machine building, output decreased by over 70% (this
also included military industry). In light industry, output in October 1998 amounted to 8.8%
of the January 1990 level. The manufacture of certain industrial products fell more than ten-
fold in 1990-2001: the share of military production, conservatively estimated at 40% of GDP
in 1990, declined six-fold in 1990-96 alone (see Yasin, 2003, pp. 417- 423).
In agriculture, harvested areas decreased from 112.1 to 82.8 million hectares, cattle
stock declined more than two-fold – from 45.3 to 22.4 million, meat production (slaughter
weight) fell from 10.1 to 5.3 million tons and milk production plummeted almost four-fold
from 20.8 to 5.3 million tons.
Table 5.2. Changes in economic structure (value added, % of GDP)
Sector 1989 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Industry 50.2 41.3 42.9 42.5 39.2 36.7 34.1 36.2 35.5 39.0 37.3
Services 33.0 51.6 49.1 51.2 52.9 55.7 58.4 58.4 57.2 54.6 55.9
Agriculture 16.8 7.1 8.0 6.3 7.9 7.5 7.5 5.4 7.4 6.4 6.8
Source: World Development Indicators Database.
Table 5.3. Changes in economy structure (% of total employment)

Sector 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Industry 40.1 39.7 38.6 38.0 35.9 34.0 32.5 30.0 29.4 29.4
Services 41.0 41.5 41.2 46.1 47.7 50.0 52.2 57.8 59.1 58.8
Agriculture 13.9 14.2 15.4 15.5 16.1 15.7 .. 12.2 11.5 11.8
Source: World Development Indicators Database
Similar to other post-communist countries, Russia witnessed profound changes in GDP

structure in favor of services in its broad sense, including trade, transport, health, education,
government services, etc. (see Table 5.2). Similar adjustments, albeit less abrupt, could also
be observed in employment structure (see Table 5.3).
58
5.3. Social indicators
A drop in real registered incomes and an increase in income inequality between Russian
households were the key social trends observed in the 1990s. Price increases surpassed
growth in nominal wages and incomes, resulting in average real earnings falling by two thirds
and real incomes by more than a half. Furthermore, the decline in wages and incomes con-
tinued until 1996, accompanied by an unprecedented increase in the non-payment of wages,
pensions and social transfers22. After the 1998 crisis, real disposable incomes fell by another
third and, as we can see from Table 5.4, their level remains far below pre-transition figures
(despite an increase in real income in 2002-2003). However, one needs also to reflect that
the pre-transition level of 'real' wages and incomes is not the best benchmark for compari-
son. Firstly, 'real' incomes/wages could hardly be called "real" in an environment of sup-
pressed hyperinflation23, an overall shortage of consumer goods and their low quality and
limited consumer choice. Secondly, during the transition the unofficial economy exploded to
a level of more than 40% of registered GDP (see Section 5.1) and became an important
additional source of income.
Table 5.4. Real incomes of Russian society, 1992-2002, as a % of the previous year
Income category 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2002, % to 1991
Real disposable 52 116 113 85 101 106 84 88 112 108 109 60.5
money incomes
Real accrued 67 71 92 72 106 105 87 78 121 120 116 40.1
employee wages
Source: own calculations based on State Statistical Committee (Goskomstat) data.
Real income trends in CIS countries appear similar to those in Russia, whereas in the CEB
countries positive growth rates of households' real incomes and expenditures had been
mostly achieved already in the first half of the 1990s, and in some countries their level had
even exceeded (or was approaching) pre-transition figures by 2000. In the Czech Republic,
for example, the average real money wage in 2000 had reached 109.8% of the 1989 level;
in Poland, Slovenia, Hungary and Slovakia these percentages amounted were 98.6%, 90.6%,
83.9% and 81.9%, respectively24.
Social transfers are an important source of income for many Russians and are granted as
cash allowances, payments in kind and subsidies to payments for services. Social transfers
22 The volume of overdue indebtedness for wages, pensions and social allowances was equal to 3.22 billion rubles in 1994;
7.8 billion rubles in 1995; 45.5 billion rubles in 1996; 69.4 billion rubles in 1997; 123.2 billion rubles in 1998; 99.5 billion rubles in
1999; 66.3 billion rubles in 2000; and 54.9 billion rubles in 2001.
23 Monetary overhang (forced savings) was estimated by Cottarelli and Blejer (1991) as close to 20% of GDP and one third
of existing financial assets.

24
TransMONEE Database 2000 and 2002.
59
paid in cash make up 13-15% of total income, of which 70-80% is allocated for pension pay-
ments. Cumulatively, they accounted for 5.2% of GDP in 1992, 7.5% of GDP in 1995, 9.9%
of GDP in 1997 (the highest share), and gradually fell to 7.8% of GDP in 2000.
Table 5.5 shows the proportion of the 'Social policy' item in the total expenditures of the
federal budget in 1995-2001. Prior to 1998, social policy expenditures accounted for 3-4 %
of the federal budget; in 1998 their share in aggregate expenditure increased to 7% and
remained at this level until 2000, when there was a further substantial increase in this item
in 2001 (Maleva, 2002). One must take into account, however, the decreasing scale of fed-
eral budget expenditures in the 1990s (in real terms and in relation to GDP). This decreas-
ing trend started to reverse in 2000.
Table 5.5. Share of the 'Social Policy' item in total federal budget expenditures, %
Year Expenditure on Including
‘Social policy’ Social aid Pensions and allowances for servicemen Other social policy
item and law enforcement employees measures
1995 4.19 3.23 - 0.96
1996 3.33 2.56 - 0.77
1997 3.37 2.6 - 0.77
1998 7.01 3.23 3.0 0.78
1999 7.28 3.2 3.36 0.72
2000 6.58 2.83 3.3 0.45
2001 9.24 3.57 3.75 1.92
Source: Maleva (2002), p. 11.
The leading reformers had a substantially larger share of social expenditures in the over-
all budget: it varied from one third of GDP (in Poland) to a quarter (in the Czech Republic,
Slovakia and Hungary). Moreover, at the first stage of reforms, as GDP declined, this share
tended to grow. This fact, together with a rapid implementation of the stabilization program
and positive GDP rates of growth, made a rapid reduction in 'social costs' possible in the first
transition stage. Countries where stabilization and output recovery were delayed (like
Russia) experienced a sharp and prolonged decline of their living standards.
As for public social services, health and education expenditures in Russia also exhibited
unstable trends, as shown in Table 5.6:
Table 5.6. Budget expenditures on health care and education, 1992-2000, as a % of GDP
Year 1992 1993 1994 1994 1996 1997 1998 1999 2000
Health care and education expenditures 6 7.2 7.7 6.3 7.4 8.7 7.4 6.6 5.9
Source: EBRD (2002).
The market transformation also changed the structure of the labor force in all transition
countries: the share of employed has declined and the share of unemployed has risen. Two
broad patterns of labor market adjustment can be identified. The first, largely associated
60
with the CIS and the countries of Southeastern Europe, involved a decline in employment
significantly smaller than the massive collapse of output and labor demand. The adjustment
took the form of lower real wages as well as the emergence of wage arrears and hidden
unemployment. Labor moved to low-productivity services and subsistence agriculture.
Alongside labor hoarding by enterprises, these sectors served as shock absorbers in view of
the lack of a well-functioning social policy.
The second pattern, broadly prevalent in the CEB countries, saw employment decline
alongside output. Job cuts were concentrated in existing enterprises, while job creation was
to be found almost exclusively in new enterprises (World Bank, 2002, p. 30)
In Russia employment cuts in ineffective sectors/enterprises were slow (compared to
output decline), leading to large-scale hidden unemployment and the growth of employment
in the shadow economy. Hidden unemployment (e.g. on long, unpaid leave or reduced
working hours) has been estimated at 8-25% of the economically active population . The
shadow economy employs about 25 million people, including 7 million without any other job,
and 18 million combining work in the formal and informal sectors. Russia is the regional
leader in terms of hidden unemployment. This can helps explain the considerable difference
between overall (ILO definition) and registered unemployment in Russia.
Figure 5.6. Total (ILO definition) and registered unemployment in Russia, as a % of the labor force
14 13.3
11.9 12
12
9.6 9.3
10 9.2 8.9
7.8 8
8
5.6
6
4.8
3.3 3.6
4 2.9 2.9
2.3
1.8 1.6 1.5 1.7
2 1.1
0.8
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Total unemployed Registred unemployed
Source: State Statistical Committee (Goskomstat)
Similar to the majority of post-communist countries, Russia set out on its transition with
one of the world's lowest levels of inequality. This reflected the ideologically driven pattern
of income policy under communism and almost total absence of the private business activi-
ty. As such, growth in inequality was unavoidable but varied greatly across the region (Table
5.7). It has increased rapidly in most CIS countries – nearly doubling in 2-3 years. Today,
Russia ranks among the world's leaders in terms of levels of inequality. In contrast to Russia
61
and the CIS, the increase of the Gini coefficient in the CEB countries has been relatively
modest. For example, in Hungary it increased from 0.21 in 1987 to only 0.25 a decade later.
Even in the Czech Republic and Slovenia, where the growth in inequality has been more pro-
nounced, the distribution of income remains fairly egalitarian.
Table 5.7. Transition countries: Gini coefficient of income per capita
Country/ Region 1987–90 1993–94 1996–98 2001
CEB 0.23 0.29 0.33
Bulgaria 0.23 0.38 0.41 0.32
Croatia 0.36 Na 0.35 0.29
Czech Republic 0.19 0.23 0.25 na
Estonia 0.24 0.35 0.37 na
Hungary 0.21 0.23 0.25 na
Latvia 0.24 0.31 0.32 na
b
Lithuania 0.23 0.37 0.34 0.36
Poland 0.28 0.28 0.33 na
b
Romania 0.23 0.29 0.30 0.30
Slovenia 0.22 0.25 0.30 na
a
CIS 0.28 0.36 0.46
b
Armenia 0.27 Na 0.61 0.49
b
Belarus 0.23 0.28 0.26 0.34
b
Georgia 0.29 Na 0.43 0.39
Kazakhstan 0.30 0.33 0.35 0.31
b
Kyrgyz Republic 0.31 0.55 0.47 0.47
Moldova 0.27 Na 0.42 0.36
b
Russian Federation 0.26 0.48 0.47 0.46
Tajikistan 0.28 Na 0.47 na
Turkmenistan 0.28 0.36 0.45 na
b
Ukraine 0.24 Na 0.47 0.46
Notes: na – not available, a – median of countries with data, b – data for 2000.
Sources: World Bank (2000b); World Bank World Development Indicators Database; EBRD (2002).
Such a huge and fast rise in inequality in Russia can be explained by the slow and incon-
sequent liberalization and macroeconomic stabilization undertaken in the first years of the
transition (see Chapter 2), which saw the state taken over in effect by narrow groups of vest-
ed interests who were largely able to adapt economic policy to meet their interests and
expected benefits, in turn limiting competition and concentrating their economic power,
often at a high social cost. As result, rent seeking and corruption, instead of fair and open
competition, have become the main sources of business success (World Bank, 2000a; 2002;
Gelb, Hillman, and Ursprung, 1995).
A more detailed analysis of differentiation and concentration of income in Russia (see

Table 5.8) shows that the share of the poorest quintile group in the total income of house-
holds continued to fall up to 1996 and remained fairly stable over the subsequent six years.
62
Table 5.8. Coefficients of differentiation and concentration of income, 1991-2000 (total money income = 100)
Quintile 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
First quintile (with 11.9 6.0 5.8 5.3 5.5 6.2 5.9 6.2 6.1 5.8 5.9 5.6
lowest incomes)
Second quintile 15.8 11.6 11.1 10.2 10.2 10.7 10.2 10.4 10.4 10.4 10.4 10.4
Third quintile 18.8 17.6 16.7 15.2 15.0 15.1 14.1 14.8 14,7 15.1 15.0 15.4
Fourth quintile 22.8 26.5 24.8 23.0 22.4 21.6 21.6 21.2 20.9 21.9 21.7 22.8
Fifth quintile (with 30.7 38.3 41.6 46.3 46.9 46.4 47.5 47.6 47.9 46.8 47.0 45.8
highest incomes)
Decile coefficient of 4.5 8.0 11.2 15.1 13.5 13.0 14.4 13.8 14.5 13.9 14.0 14.0
differentiation
Source: State Statistical Committee (Goskomstat).
The shares of the second, third and fourth quintiles continued to fall over the whole period
(from 57.4% to 46.4%). Thus, the financial position of middle-income groups (potential mid-
dle class members) deteriorated. At the same time, the income share of the top 20% (the
most affluent part of the population) has risen to almost a half of the total.
All the transition countries recorded a sharp growth in the poverty rate. In Russia, the
poverty peak of 1992-93 was due to price liberalization which resulted in a 40% decline in
officially recorded personal real incomes. Another fall was experienced in 1999 as a conse-
quence of the 1998 financial crisis. (see Table 5.9).
Table 5.9. Population with money incomes below minimum subsistence level
Item 1992 1994 1995 1996 1997 1998 1999 2000 2001 2002
Million people 49.7 33,3 36.3 32,5 30.3 34.0 41.2 41.9 39.4 35.8
Percent of the total popul ation1 33.5 22,4 24.7 22,0 20.7 23.3 28.3 28.9 27.3 25.0
Annual % change ... … 109.0 89.5 93.8 112.2 121.2 85.0 94.0 90.9
Note: 1 Methodology used to estimate the share of population with money incomes below subsistence level has repeatedly
changed over time. Thus, the data above are hardly comparable. For instance, if we use the system of income estimation of 1992
(the number of persons registered as poor at that time was 33.5%), then in 1994 the share of population below the poverty
line would have been 34% and in 2000 28%. However, if we consider incomes from the unofficial sector, then in 1994 the share
of the poor shrinks to 22%, but grows to 29.9% in 1999 (see Maleva, 2002).
Source: State Statistical Committee (Goskomstat)
Among many composite indices of quality of life developed over the past two decades
(see Booysen, 2002, for elaboration), the UNDP human development index (HDI) is by far
the most widely used.
Providing a simple summary measure of three dimensions of human development (living
a long and healthy life, being educated and having a decent standard of living), the index com-
bines measures of life expectancy, school enrolment, literacy and GDP per capita to offer a
broader view of a country's development than using income alone.
Table 5.10 demonstrates that, as opposed to Russia, where HDI value declined steadily
in the period 1985-1995, the majority of CEB countries either increased or maintained HDI
scores throughout the whole transition period.
63
Table 5.10. Human Development Index Trends 1985-2001

HDI Rank in 2001 Country 1985 1990 1995 2001
29 Slovenia .. 0.843 0.851 0.881
32 Czech .. 0.835 0.843 0.861
Republic
35 Poland .. 0.794 0.81 0.841
38 Hungary 0.803 0.803 0.807 0.837
39 Slovakia .. .. .. 0.836
41 Estonia 0.818 0.814 0.793 0.833
45 Lithuania .. 0.819 0.785 0.824
50 Latvia 0.803 0.803 0.761 0.811
57 Bulgaria 0.79 0.792 0.784 0.795
63 Russia 0.811 0.809 0.766 0.779
72 Romania 0.782 0.768 0.765 0.773
75 Ukraine .. 0.797 0.748 0.766
76 Kazakhstan .. 0.781 0.738 0.765
88 Georgia .. .. .. 0.746
89 Azerbaijan .. .. .. 0.744
100 Armenia .. 0.756 0.709 0.729
102 Kyrgyzstan .. .. .. 0.727
108 Moldova, 0.739 0.756 0.704 0.7
113 Tajikistan 0.736 0.736 0.665 0.677
Source: HDR (2003).
5.4. Structural and institutional reforms
Corporatization and privatization in Russia were more rapid than in the majority of CEE
and CIS countries. In 1999, the private sector in Russia produced about 70% of GDP as com-
pared to 5% in the pre-transition period (see Table 5.11).
Table 5.11. Privatization results in selected CEE and CIS countries
Country/ region Private sector share in GDP, % Privatization Corporate governance
1990 1994 1999 Mid-2001 large Small & structural reforms
CIS 10 20 50 -
Armenia 12 40 60 70 3+ 4- 2+
Belarus 5 15 20 20 1 2 1
Russia 5 50 70 70 3+ 4 2+
CEB 11 50 68 -
Hungary 18 55 80 80 4 4+ 3+
Romania 17 40 60 65 3+ 4- 2
Czech Republic 12 65 80 80 4 4+ 3+
Estonia 10 55 75 80 4 4+ 3+
Source: EBRD (2002)
64
Table 5.12. EBRD indices of structural reform and institution building in Russia
Reform sphere 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Liberalization
Price liberalization 3 3 3 3 3 3 2,7 2,7 3 3
Liberalization of trade and exchange operations 3 3 3 3 4 4 2,3 2,3 2,3 2,7
Privatization
Privatization of small enterprises 2 3 3 4 4 4 4 4 4 4
Large-scale privatization 2 3 3 3 3 3,3 3,3 3,3 3,3 3,3
Enterprises
Enterprise restructuring 1 1 1,7 2 2 2 2 1,7 2 2,3
Business environment 2 2 2 2 2 2,3 2,3 2,3 2,3 2,3
Infrastructure
Reforms in infrastructure - 1,3 1,7 1,7 2 2 2 2 2 2
Financial organizations
Banking system reform 1 1 2 2 2 2,3 2 1,7 1,7 1,7
Reform of non -banking financial institutions 1 1,7 1,7 2 3 3 1,7 1,7 1,7 1,7
Judiciary base (corporate law)
Legislative sphere - - - - - 3,3 3,7 3,7 3,7 3
Law enforcement efficiency - - - - - 3 2 2,3 3 3,7
Note: Structural and institutional changes are scored on a one-to-four scale.
Source: EBRD (2001; 2002)
Over 140,000 enterprises have been privatized in Russia since 1992. The EBRD rates the
results of Russian privatization positively: 3.3 for large-scale privatization and 4.0 for small
privatization. However, the ratings for corporate governance and structural reform (2.3),
enterprise restructuring (2.3) and business environment (2.3), provide a more mixed picture
(see Table 5.12, which also contains other indices of structural and institutional reform).
Unlike in the leading transition countries, in Russia the establishment of new ('green field')
private firms has not become a major source of private sector growth. This can be explained
by bureaucratic and administrative barriers, widespread corruption, lack of transparency,
instability and contradictions in economic legislation, i.e. high transaction costs, which reflect
the poor business and investment climate. While small private businesses exhibited relative-
ly rapid growth in the early years of Russia's transition (their share in value added more than
doubled, from 10% to 23%, between 1991 and 1998), their number and shares of total
employment and output have virtually stagnated since the mid-1990s. This is in striking con-
trast both to the overall economic expansion of 2000-2002 and the situation in the CEB
region, where SME development is regarded as the basis for future economic growth, and
the shares of new private enterprises in employment and value added exceed 40% (World
Bank, 2002, pp. 40-42).
The estimated expenses of Russian entrepreneurs overcoming administrative barriers
and bureaucratic control accounted to USD 8-8.5 billion (about 1% of GDP based on pur-
chasing power parity) in 2000 (Kryuchkova, 2001, p. 19, quoted by Yasin, 2003, p. 212).
65
5.5. Composite development indicators
The composite indicators calculated by various independent organizations confirm the

relatively poor institutional characteristics of the Russian state and economy and a lack a vis-
ible progress in this sphere. These are related not only to the economic system but also to
the areas of human rights, civil liberties, democratization, the quality of the legal system, jus-
tice administration, corruption, etc.
5.5.1. Freedom House indices
Since 1972, the Freedom House has published an annual assessment of political freedom
worldwide on the basis of political rights and civil liberties, using a one-to-seven scale. Those
countries with rating averages of 1-2.5 are generally considered 'free', those with 3-5.5 –
'partly free', and 5.5-7 as 'not free'.
Russia rated by FH since 1991, while technically remaining in the 'partly free' category,
has seen a steady decrease in its rating, closely approaching 'not free' status (see Table 5.13).
This remains in sharp contrast to the dramatic progress in democratization and human rights
in CEB countries, which have moved from 'not free' to 'free' status over the past decade.
More importantly, the progress in democratization and human rights standards has been
closely correlated with progress in economic reforms. While causality here has been in both
directions, the key element lies in political reforms acting as a factor determining economic
progress and the business climate (see Chapter 3 and Dabrowski and Gortat, 2002).
Similarly to worldwide indicators, FH since 1997 in its 'Nations in Transit' study, has pro-
vided subcategory ratings and averaged scores that are signposts of progress or regress in
Table 5.13. Russia's 'Freedom in the World' Ratings, 1991-2002

Years Score Category
1991-92 3,3 PF
1992-93 3,4 PF
1993-94 3,4 PF
1994-95 3,4 PF
1995-96 3,4 PF
1996-97 3,4 PF
1997-98 3,4 PF
1998-99 4,4 PF
1999-00 4,5 PF
2000-01 5,5 PF
2001-02 5,5 PF
Source: FH (2003a).
66
political and economic reforms in 27 CEE and FSU countries. These scores are based on the
following categories and subcategories: democratization (electoral process, civil society,
independent media and governance), rule of law (constitutional, legislative and judicial frame-
work), and (until 2002) economic liberalization (privatization, macroeconomic and micro-
economic policy).
Table 5.14 indicates an ever-widening gap between Russia and CEE both in democratiza-
tion and the rule-of-law categories (although Russia noted some improvement in the latter
part in 2002). In the six transition categories which FH tracks Russia has experienced regress
in all but one (corruption) since 1997.
Table 5.14. 'Nations in Transit' Scores, 1997-2003
Country/ Indicator 1997 1998 1999-2000 2001 2002 2003
Russia
Democratization 3.80 4.10 4.25 4.63 4.81 4.88
Rule of Law na na 5.25 5.38 5.38 5.13
Economic Liberalization, incl.: 3.50 3.92 4.33 4.17 3.92 na
Privatization 3.00 3.25 3.75 3.75 3.50 na
Macroeconomic Policy na 4.25 4.75 4.25 3.75 na
Microeconomic Policy na 4.25 4.50 4.50 4.50 na
CEE averages
Democratization 2.86 3.12 2.98 2.82 2.73 2.68
Rule of Law na na 3.69 3.59 3.51 3.43
Economic Liberalization 3.14 3.37 3.30 3.25 na na
Sources: FH (2002; 2003)
5.5.2. Transparency International Corruption Perceptions Index
The TI Corruption Perceptions Index (CPI) ranks 102 countries in terms of the degree
to which corruption is perceived to exist among public officials and politicians. The CPI score
is rated on a scale from 1 to 10 – a perfect 10.00 would be a totally corruption-free coun-
try.
While most CEE countries are perceived to be increasingly less corrupt, Russia, as well
Table 5.15. The Corruption Perceptions Index, 1998-2002
1998 1999 2000 2001 2002
Country
Score Rank Score Rank Score Rank Score Rank Score Rank
Russia 2.4 76 2.4 82 2.1 82 2.3 79 2.7 71
Estonia 5.7 26 5.7 27 5.7 27 5.6 28 5.6 29
Hungary 5.0 33 5.2 31 5.2 32 5.3 31 4.9 33
Poland 4.6 39 4.2 44 4.1 43 4.1 44 4.0 45
Slovenia na Na 6.0 25 5.5 28 5.2 34 5.7 28
Ukraine 2.8 69 2.6 75 1.5 87 2.1 83 2.4 85
Source: http://www.transparency.org
67
as many FSU countries, remains ridden with corruption (see Table 5.15). The recent steps
undertaken in Russia to introduce tax reforms and new legislation combating money-laun-
dering may bring improvement in future rankings.
5.5.3. The Heritage Foundation Index of Economic Freedom
Since 1995, the HF Index of Economic Freedom rates each country by studying 50 inde-
pendent economic variables. Economic freedom is defined as the absence of government
coercion or constraint on the production, distribution and consumption of goods and ser-
vices beyond the extent necessary for citizens to protect and maintain liberty itself.
The analyzed variables fall into 10 broad categories: trade policy, fiscal burden of gov-
ernment, government intervention in the economy, monetary policy, capital flows and for-
eign investment, banking and finance, wages and prices, property rights, regulation and black
market activity. Each factor is scored according to a grading scale from 1 to 5: a score of 1
signifies a set of policies that are most conducive to economic freedom, while a score of 5
signifies a set of policies that are least conducive (Beach and O'Driscoll, 2003).
Table 5.16. The HF Index of Economic Freedom, 1995-2003
Year Russia Estonia Hungary Poland Slovenia Ukraine
1995 Score 3.40 2.40 3.00 3.30 na 3.70
Rank 69 18 41 59 na 85
1996 Score 3.50 2.50 3.00 3.10 3.50 3.80
Rank 93 28 61 71 93 118
1997 Score 3.55 2.50 3.00 3.10 3.30 3.75
Rank 106 32 68 73 89 122
1998 Score 3.35 2.30 3.00 2.90 3.00 3.80
Rank 95 24 71 61 71 123
1999 Score 3.50 2.35 2.95 2.80 2.90 3.60
Rank 110 30 69 52 62 126
2000 Score 3.70 2.20 2.55 2.80 3.00 3.60
Rank 122 22 41 53 74 116
2001 Score 3.70 2.05 2.55 2.75 2.90 3.85
Rank 127 14 42 54 63 133
2002 Score 3.70 1.80 2.40 2.70 3.10 3.85
Rank 131 4 32 45 79 137
2003 Score 3.70 1.80 2.65 2.90 2.85 3.65
Rank 135 6 44 66 62 131
Source: O'Driscoll, Feulner, and O'Grady (2003).
As Table 5.16 indicates, Russia is the only country (among the chosen set of transition
economies) to have demonstrated a consistent deterioration in its degree of economic free-
dom in the course of the past eight years and remains among the least free countries in the
68
region. Despite several achievements in the economic sphere (e.g. tax reform), the trend
toward increased political and administrative regulation is characterized by a growing
bureaucracy, cutbacks in regional autonomy, interference in regional elections, crackdowns
on the independence of the media, the granting of increased power to the country's securi-
ty agencies and a reluctance to introduce military and judicial reforms (O'Driscoll, Feulner,
and O'Grady, 2003). Across the board, Russia scores poorly in almost all of the factors, with
the one exception of government intervention (2.5). Moreover, similar to the FH indices, HF
figures indicate a widening gap between Russia and the CEB countries.
5.5.4. The Fraser Institute's Economic Freedom of the World (EFW) Index
Somewhat similar to the HF index, the EFW index measures the degree of economic
freedom across 123 countries in five major areas: size of government (expenditures, taxes,
and enterprises); legal structure and security of property rights; access to sound money;
freedom to exchange with foreigners; and regulation of credit, labor, and business. Counting
the various sub-components, the EFW index utilizes 38 distinct pieces of data. Each compo-
nent and sub-component is placed on a scale from 0 to 10 reflecting the distribution of the
underlying data. The component ratings within each area are averaged to derive ratings for
each of the five areas. In turn, the summary rating is the average of the five area ratings
(Gwartney and Lawson, 2003, p. 6).
Table 5.17. EFW Index , 1990-2001

Year Russia Estonia Hungary Poland Slovenia Ukraine
1990 Score na na 5.0 4.0 Na na
Rank na na 74 101 Na na
1995 Score 4.0 5.6 6.3 5.3 4.9 3.5
Rank 116 74 46 82 92 122
1997 Score 5.1 6.7 7.2 6.2 5.9 4.2
Rank 91 54 47 61 73 108
1999 Score 3.9 7.4 7.1 5.7 6.2 4.6
Rank 117 36 43 85 72 106
2000 Score 4.5 6.9 6.6 5.8 5.9 4.5
Rank 118 41 52 81 77 118
2001 Score 5.0 7.5 7.0 6.0 6.1 4.6
Rank 112 16 35 77 73 117
Source: http://www.freetheworld.com/2003/EFW2003Dataset.xls
Similarly to the HF index, the EFW index rates Russia very close to the bottom of the
country list (Table 5.17). One important difference, however, are the positive, albeit slight,
dynamics of the EFW index scores: Russia's rating rose from 116 to 112 (out of 123) between
69
1995 and 2001. Across the board, Russia (like most post-communist countries) rates rela-
tively better in freedom of foreign trade (74, on a par with Poland) and size of government
(73, higher than most CEB economies), but lags far behind in access to sound money (112)
and especially in regulation of credit and business (119).
70
6. Main Hypotheses and Results
of Their Testing
When we started our work we formulated six preliminary hypotheses partly following
proposal formulated by Schmidt-Hebbel (2003). These hypotheses were tested using most-
ly a narrative, qualitative analysis method. Below we summarize our main findings, confirm-
ing or rejecting these hypotheses. The findings are based on analyses conducted in the pre-
vious chapters of this study.
6.1. Hypothesis 1: Domestic crises beget reforms
According to the findings of much research into the political economy of policy reform
(see e.g. Williamson, 1994; Drazen and Easterly, 2001; quoted by Fidrmuc and Noury, 2002,
Blaszkiewicz and Paczynski, 2003) 'crises induce reform'. The mechanism here seems to be
rather straight forward: the previous political and economic system (or one of them)
becomes increasingly ineffective and needs correction. However, defenders of the status
quo are much stronger than advocates of change, which means reforms blocked. In the
meantime inefficiencies/ distortions/ imbalances/ conflicts caused either by flawed institu-
tions or bad policies, or both, gradually cumulate, leading to a crisis. A crisis itself can also
be provoked by an external economic or political shock. As a result of the crisis the domi-
nant anti-reform coalition may collapse or become seriously weakened and advocates of
changes gain strength.
The history of the Russian transition (see Chapter 2) clearly demonstrates that reforms
were generated by the development of the preceding crisis. Starting from the very beginning
of the analyzed period, Gorbachev's Perestroika was pushed by the deep systemic crisis of the
centrally planned economy and its inability to generate further economic growth (see Ofer,
1987; Gaidar, 1997; Aslund, 2002). Russia's average rate of economic growth consistently
declined throughout the 1970s and 1980s and the Soviet leadership faced increasing prob-
71
lems in meeting the challenges posed by the Arms Race and the ideological and geopolitical
confrontation with the US and the rest of the free world.
The limited character and inefficiency of Gorbachev's reforms (particularly in the eco-
nomic sphere) led eventually to the hidden hyperinflation of 1990-1991, and in turn to the
collapse of the communist economic and political regime, the dissolution of the Soviet Union
in 1991 and gave birth in effect to the 'revolutionary' period of Russia's reforms.
As the 'revolutionary' reforms initiated at the end of 1991 by President Boris Yeltsin and
Yegor Gaidar were insufficiently fast, consistent or fully thought out due to the limited polit-
ical window of opportunity and lack of sufficient strength of the pro-reform coalition (see
below), macroeconomic performance remained poor (see Chapter 5). Chronic macroeco-
nomic instability led to a series of currency crises, including 'Black Tuesday' of October 11,
1994, which opened the door to the more thorough stabilization policy of 1995 at least in
the monetary policy sphere.
The period 1996-1997, while continuing the fragile and illusory price and monetary sta-
bility achieved in 1995, contributed to a building up of huge fiscal imbalances. The subse-
quent attempts at fiscal adjustment and structural and institutional reform failed because of
opposition from the communist-dominated Duma and the influence of powerful 'oligarchs'
lobbies. Again it had to lead to crisis.
The August 1998 financial crisis seriously reshaped both the political map of Russia and
the configuration of special interest groups. With a certain time-lag it helped to elect an eco-
nomic reform-friendly parliament (December 1999) and President (March 2000), contribut-
ing to a consolidation of political power. In turn, a comprehensive reform package (the so-
called Greff program) could be implemented in a more consistent and thorough way than
previous reform attempts.
Summing up, each of the above mentioned crises reflected the lack of possibility of car-
rying on the previous ineffective policies. By generating economic and political shock across
the whole of society and political elite, each subsequent crises helped to weaken the domi-
nant groups of special interests and soften their resistance to necessary adjustment. Thus,
Russia's experience appears to support the observation that 'crises induce reform' and helps
explain, in political economy terms, the mechanisms that transmit crisis shock into new
rounds of reform.
6.2. Hypothesis 2: External factors shape reform
In many countries the role of various external factors, such as economic shocks coming
from international/ regional markets, learning/imitation from other countries, the influence
72
6. Main Hypotheses and Results of Their Testing
of the IMF, World Bank, WTO and other international organizations, and finally EU accession
prospects, have all played a powerful role in shaping the pace of economic (and political)
reform. However, in the case of Russia their influence seems to have been less explicit than,
for example, the role of domestic political and economic crises described in the previous
subsection. In order to verify more precisely this important hypothesis we will try to analyze
separately five main components of the 'external factors' vector, i.e. (i) changes in oil prices,
(ii) the situation on the international financial markets, (iii) foreign aid, (iv) the role of inter-
national organizations and (v) learning from other countries' experiences.
6.2.1. Oil prices
A particular role in Russia's reform history has been played by fluctuations in internation-
al oil prices – the major export commodity of the country. However, this role has not been
as explicit as one might expect, particularly bearing in mind the experience of other oil-
exporting countries.
Two oil shocks in the 1970s increased oil prices more than ten-fold (see Table 2.1 in
Chapter 2). This allowed the USRR to continue its heavily distorted industrialization strategy
and forget about the necessity of reforming its economic and political systems for at least
another decade (see Gaidar, 1997, Chapter 5). The decline in oil prices in the second half of
the 1980s worked in the opposite direction, however, creating an additional incentive (apart
from domestic and geopolitical considerations) to find a new economic mechanism aimed at
increasing the effectiveness of the Soviet economy. However, another increase in oil prices at
the beginning of the 1990s and then a stabilization at a relatively high level did not have any
visible impact on the 'revolutionary' phase of reforms (neither helping, nor halting reforms).
The decline in oil prices in 1997 and 1998 (a relatively short-living consequence of the
Asian financial crisis) contributed, to a certain extent, to the crisis developments in 1998 but
cannot be considered as the major factor responsible for the eruption of the crisis (again this
was mainly driven by domestic policy weaknesses).
Finally, the increase in oil prices starting in the second half of 1999 helped to restore eco-
nomic growth, the balance of payments and fiscal equilibrium and lower the social costs of
the reform package implemented at the beginning of the 2000s. On the other hand, it also
lowered incentives to reform ineffective public services such as national defense, police and
other law-enforcement agencies. It also made it possible to finance the Second Chechen War
without visible negative consequences for fiscal balances. Deterioration of non-oil fiscal bal-
ances in the beginning of the 2000s (reflecting a trade-off between real fiscal adjustment and
consuming 'windfall' oil revenues) is well illustrated in Figure 6.1.
73
Figure 6.1. Oil and Non-oil Fiscal Balances
Note: 1 Federal budget operations (commitments).

Source: IMF World Economic Outlook 2003, p. 42.
6.2.2. International financial markets
In this area it makes most sense to analyze only a relatively short period of time, 1996-
1998, i.e. starting with the opening of the domestic T-bills market to foreign investors in
1996 and ending with the August 1998 financial crisis (which closed Russia's access to inter-
national markets for many years). In 1996 and the first half of 1997 huge investor optimism
in relation to emerging markets helped bring in relatively large and cheap capital inflows into
Russia, thus in turn softening borrowing constraints faced by the federal government.
Without this source one might have expected two hypothetical scenarios: either a financial
crisis would have happened earlier (end of 1996 or early 1997) or government/ parliament
would have been forced to conduct fiscal adjustment.
The situation changed after the Asian crisis, which hit investor sentiment in emerging
markets, particularly in countries with weak fundamentals. This factor additionally compli-
cated the macroeconomic situation in Russia at the end of 1997 and first half of 1998 and
probably accelerated the beginning of the August 1998 crisis. However, it did not play a fun-
damental role itself in provoking the crisis (which should be attributed more to domestic fis-
cal imbalances and delaying structural and institutional reforms) and determining the course
of the reform process in Russia.
6.2.3. Foreign aid
The importance of foreign aid in leveraging the Russian reforms has generally been limit-
ed and its influence on domestic policy agenda somewhat controversial. In spite of the strong
74
political engagement of the US and other G-7 governments and relatively substantial finan-
cial and technical assistance provided by bilateral and multilateral donors (see Chapter 4),
one would be hard pressed to claim that these interventions helped build a pro-reform coali-
tion in Russia or lower the social costs of economic reforms.
The crucial problem was connected with the timing of this assistance. The initial political
window of opportunity for carrying out radical reforms was relatively weak and limited in
time compared, for example, to the CEB countries (see Chapter 2). It started after the fail-
ure of Yanaev's coup d'etat in August 1991 but had already at least partly closed after the
April 1992 Congress of People Deputies (see Gaidar, 1999; Mau, 1996).
However, more substantial Western aid started to come in the second half of 1992 only
when the limited political window of opportunity was already partly closed. The same hap-
pened with a short window of opportunity created by the defeat of a key anti-Yeltsin rebel in
October 1993. Far from it, in fact, with the IMF and World Bank (under G7 political guidance)
evidently overestimating the political window of opportunity connected with the government
of 'young reformers' in 1997 (see Zanini, et al., 2002; Zhavoronkov, 2001). The lack of coor-
dination between domestic political conditions and aid flow is well illustrated by Figure 6.2.
Figure 6.2. Support to reformers and financial aid of major donors, 1991-1999
60
50
40
30
Reforms' Support, %
20
Major donors aid, USD bn
10
0
1991 1992 1993 1994 1995 1996
1997 1998 1999
Note: The level of support to reformers was calculated as the percentage of their electoral support or their rating registered
by public opinion polls, as follows: June 1991 Presidential election voting for Yeltsin, April 1993 referendum – answer 'Yes" to
the second question on support for economic reforms; December 1993 Duma elections – the sum of votes for democratic par-
ties (Democratic Choice of Russia, RMDR, Yabloko) lists; 1995 Duma elections – the sum of votes for party lists of DCR, 'Russia,
Forward!' and a number of small reformist groups; 1996 presidential elections (right-wing liberals plus the conditional 10% of
Our Home Russia); 1997 – B. Nemtsov's rating until the last quarter (almost 18%); 1999 Duma election – support for SPS
(Union of Right Forces) and Yabloko.
Source: GAO (2000) and IET research on election support for reformers.
The question of the timing of aid to Russia has been the subject of controversy in the rel-
evant economic literature. For example, Jeffrey Sachs (1994a; 1994b) claims that providing
75
massive assistance to Russia as early as the end of 1991 and beginning of 1992 would have
helped extend the window of opportunity and maintain the reform momentum, on one hand,
and increase Western influence on the course of the Russian reforms, on the other. Failing to
do it meant losing a unique historical chance for a fast and effective transition in Russia.
Although very appealing, the idea of bringing massive assistance to Russia at this early
stage at the end of 1991 does not look ex post very realistic for several reasons.
Firstly, Russia was not yet an IMF or World Bank member at that time (it joined both
organizations in June 1993). As such, any large-scale Western financial aid would have to be
provided on a bilateral or multilateral basis by the G7 outside IMF and WB channels (see also
Rostowski, 2001 on this topic).
Secondly, G7 governments were not conceptually, technically or organizationally pre-
pared to provide such large-scale assistance to Russia at that time. The same concerns the
IMF and World Bank. In addition, knowledge about real Russian assistance needs was very
limited on both sides (i.e. the Russian and donor side).
Thirdly, the Russian authorities did not have the adequate administrative and technical
capacities to absorb larger scale financial (and technical) assistance at that time.
Finally, one should answer the most important question: could such large scale assistance
at the very beginning of Russia's transition (end of 1991, beginning of 1992) really have
changed the course of economic (and political) events in this country in favor of faster and
more thorough reforms? There are many doubts on this score. The politics and political
economy of the Russian transition was so complicated from the very beginning (and anti-
Western sentiments were strong) that Western financial assistance would hardly widen the
political window of opportunity. Wasting this assistance for current consumption and delay-
ing reforms (which was, by the way, a typical effect of substantial trade credits obtained by
Russia during the last years of Perestroika and at the beginning of the 1990s) seemed to be
a more likely scenario.
6.2.4. The role of international organizations
The IMF and World Bank had some influence on the short-term reform agenda and its tech-
nical characteristics but failed to create sufficient long-term incentives for the reform process
through their policy conditionality (see Chapter 4 for details). Their interventions did not help
build a pro-reform coalition inside the country nor the country's ownership of economic
reforms. Even worse, between 1995 and 1998, the soft and inconsistent conditionality of IMF
programs contributed to the building up of an illusion of macroeconomic stability, which in fact
was very fragile and unsustainable, i.e. misleading, in some way, Russian policymakers and finan-
cial market players (see Gianini et al, 2002; Antczak, Markiewicz and Radziwill, 2003).
76
Starting from 2000 the prospect of joining the World Trade Organization has had a cer-
tain influence on economic legislation and economic policy, particularly in the area of trade
regime, taxation, corporate and banking law, standardization, protection of intellectual prop-
erty rights, etc. However, the speed of this adjustment has not been very high and the WTO
accession process may take another couple of years.
In future, a similar influence may possibly be attributed to Russia's cooperation with the
EU – particularly the long-term goal of creating a Common European Economic Space
between Russia and the enlarged EU, which may impact several areas of institutional reform
in the economic and political spheres.
6.2.5. The experience of other countries
Learning from other countries' experience also had some, but very limited, influence on
the course of domestic professional and economic debate. While CEB countries (mainly
Poland) served as positive examples of successful reforms, the experience of Ukraine,
Belarus and Bulgaria (in the mid 1990s) was sometimes used as a warning signal demon-
strating the negative consequences of populist ideas and policies. The Latin American expe-
rience (both positive and negative) was also discussed in professional circles.
6.3. Hypothesis 3: Reform success depends on the organization

of winners
This seems to be a very obvious if not rather trivial hypothesis. At the same time, how-
ever, following this kind of recommendation in a practical sense in the post-communist tran-
sition was almost impossible for one simple reason: the future winners of the on-going
reforms were hard to organize because either they lacked power or did not exist at all at the
very beginning of transition (like private entrepreneurs or the middle class). In contrast,
potential reform losers were fewer and wield more power and therefore have been more
likely to organize interest groups opposing reforms (see Olson, 1994; Schmidt-Hebbel,
2003). In addition, some early (intermediate) winners may not necessarily have had the
chance to become ultimate winners so will have the temptation to seek to take control over
the reform process in order to put a stop to it, slow it down or distort in favor of their inter-
ests (see below).
In the case of former communist countries initial support for market reforms was not
explicit in the sense that while people realized the inefficiencies and distortions of the com-
77
mand economy they did not really understand what specifically must be done in order to
make the economic system effective and internationally competitive, and what would be the
social costs of such reforms (including the costs of their own adaptation). The dominant feel-
ing was against communism and the command economy rather than for any concrete eco-
nomic reform blueprint. Generally, a lot of wishful thinking and economic illusions accompa-
nied the collapse of communism.
Thus, support for radical economic reform had an indirect character: it was connected
with the anti-communist, pro-freedom, pro-democratic and pro-independent movement. If
people, and particularly the political elite, understood that an open and efficient market
economy was an absolutely necessary condition for building democracy, freedom and an
independent national state they could provide relatively strong (though not indefinite – see
Section 6.5) support for the economic reforms. This was the case of the CEB countries. As
we mentioned in Chapters 2 and 3, initial support for democracy and freedom in Russia was
much weaker and the 'independence' factor played no role (on the contrary, political and
market reforms were associated with the collapse of Soviet empire – see Chapter 2). So the
organization of political support for reforms became even more important and difficult than
in countries with a larger political window of opportunity.
The organization of reform supporters/ winners can be considered at least on two lev-
els: macro and micro. The first relates to the organization of a national political scene. In
some transition countries a mass anti-totalitarian and pro-independent movement
('Solidarity' in Poland, 'Sajudis' in Lithuania, the civic movement in Czechoslovakia) also pro-
vided support for the initial economic reform package. In Russia the situation was again more
complicated. The existing anti-totalitarian and pro-democratic organizations of the
Perestroika period, like 'Democratic Russia', were not strong enough and lacked a clear eco-
nomic program. On the other hand, the political camp which supported Boris Yeltsin in June
1991 Presidential election and resisted the August 1991 attempt at a coup d'etat was very
heterogeneous in terms of its political and economic ideas and interests. So the economic
reformers who came into government in November 1991 had to organize their own politi-
cal base from scratch25.
They managed to meet this challenge and built a relatively stable pro-market political for-
mation (Democratic Choice of Russia/ Union of Right Forces). However, this grouping never
enjoyed strong electoral support and its ability to build a wider and stable pro-reform coali-
tion was limited. The latter changed after 1999 when so-called 'centrist' (pro-Kremlin) for-
mations became more market oriented and when the goal of building a strong Russian state
started to be identified with a well functioning market economy. In the meantime (and par-
ticularly in the early years of the transition) the advocates of radical market reforms were
13 The importance of building their own political base by economic reformers was underlined several times by the current
President of the Czech Republic Vaclav Klaus (see e.g. Klaus, 1997). See also Gaidar (1999).
78
forced to make compromises with their political opponents. As we demonstrated in

Chapters 2 and 3, many of these compromises were counter-productive for reformers
because they only strengthened the anti-reform coalition instead of building a pro-reform
one26.
In addition, the failure to reform the courts and law enforcement agencies at the very
beginning of the reform process not only contributed to a significant deterioration in the
business and investment climate (see Chapters 3 and 5) but also created fertile ground for
their 'capture' by the oligarchs, strengthening in this way the anti-reform coalition. The same
concerns the distorted privatization of the electronic mass-media and control over media
that formally remained in state hands (Zhavoronkov and Yanovskij, 2001).
When we look at a micro level, ex ante identification of potential winners has proved to
be very difficult27. Ex post sociological analyzes clearly show that reform winners have been
those who have shown a strong ability to adapt themselves to new market conditions (see
Chapter 3). Unfortunately, the concrete policies conducted in the 1990s, often determined
by political compromises (see above), damaged the interests of many of such defined win-
ners. Failure to deconcentrate and demonopolize many important sectors, over-regulation,
administrative harassment and corruption and privileges to the oligarchs, have all hampered
the development of new small and medium sized private enterprises (see Chapter 5) and the
building of a middle class. Failure to reform public services such as education, health care and
public administration has contributed to a pauperization of the another potential part of a
middle class, i.e. 'white collars' workers, civil servants and the intelligentsia, pushing many of
them into the anti-reform camp. In addition, as we demonstrated in Chapter 3, federal fiscal
transfers have helped opponents of reforms rather than reform winners and supporters (at
least up to the end of the 1990s).
Summing up, the history of the Russian reforms confirms the importance of the organi-
zation of reform winners, but at the same time shows how difficult this task is in the case of
a fundamental post-communist transition.
6.4. Hypothesis 4: Sequencing matters – virtuous vs. vicious

cycle
The proper reform sequencing of the first stage of reforms has a strong impact on their
subsequent course. Early liberalization and macroeconomic stabilization: (i) eliminates many
26
Zhavoronkov and Yanovskiy (2001) quote the political statement of Yegor Gaidar when he analyzed the causes of the
reformers' failure in 1997-1998: 'Each single compromise seemed to be reasonable and justified but all together went too far'.
27 See Mau (1996) on the attempt to identify pro- and anti-inflationary forces in the early 1990s.
79
potential sources of rent; (ii) gives more open and equal opportunities to participate in busi-
ness activity; (iii) minimizes income and wealth distortions; and (iv) provides opportunities
for higher economic growth. The early success of the economic transition helps strengthen
the constituency in favor of further reforms, both political and economic, triggering a kind of
'virtuous' circle or positive 'multiple equilibria'. This kind of scenario has been generally
observed in the CEB region.
In contrast, too many compromises or improper sequencing of reforms (delayed stabi-
lization and liberalization) in the early stage of transition can contribute to building a hybrid
economic regime and powerful group of interests defending the intermediate status quo (see
Krueger, 1993; Hellman, 1998). This is what happened in Russia, where various kinds of rent
opportunities, from high inflation, multiple exchange rates, direct and indirect subsidies, tax
exemptions, selective trade barriers, widespread licensing, weak banking supervision and
non-transparent privatization process contributed to the building of oligarchic fortunes. The
oligarchs captured most of the basic public institutions – executive, legislative and judicial
power, regional and local self-government, political parties, and mass media, using them to
enhance their own benefits and halting reforms whenever they have considered them to be
challenging to their interests. The excessive income and wealth differentiations, deprivation
of equal access to business activity for most of the society, widespread poverty, frustration
and political apathy are the other side of the same coin. This has led to lower public demand
for market reforms, creating a kind of 'vicious cycle' (or negative 'multiple equilibria').
The above described 'vicious cycle' (or 'reform trap'), which dominated in Russia through
most of the 1990s, started to be reversed after the 1998 financial crisis. However, it took
some time before the reform process gathered political momentum in fact, it happened
only after the Presidential election of March 2000. The demand for reforms and market insti-
tutions started to increase when a significant part of the political and business elite had adapt-
ed itself to the new capitalist environment and become more interested in stable and trans-
parent rules of the game. This process was further strengthened by the emergence of a larg-
er group of small, medium-sized and large private entrepreneurs as well as other medium-
class representatives who demanded equal access to business opportunities and the elimi-
nation of at least part of the administrative rents (which they had to pay). The results of the
1999 Duma elections well reflected the changing preferences of Russian society.
On the other hand, the financial crisis of 1998 forced the authorities to increase the level
of fiscal and payment discipline, thus diminishing significant sources of rent extraction. In addi-
tion, the favorable external environment (high oil prices) allowed the social costs of the reforms
to be lowered somewhat. This provided a chance to build a pro-reform coalition and initiate a
'virtuous' cycle (positive 'multiple equilibria') in turn underpinning further necessary changes.
The Russian reform experience positively verifies the hypothesis on reform equilibria
('virtuous' vs. vicious cycle).
80
6.5. Hypothesis 5: Fast reforms are more effective than slow

ones
The question of the optimal reform speed has been subject of many key debates, partic-
ularly in the context of the post-communist transition28. In a more journalist fashion this con-
troversy has frequently been called the 'shock-therapy vs. gradualism' debate, although the
notion of 'shock therapy' seems to contain a rather emotional and pejorative association.
The arguments in favor of fast, comprehensive and thorough reform rather than slow and
gradual reform refer mainly to three groups of issues:
• Expectation/ credibility when policymakers want to radically change the behavior of
economic agents. This is quite obvious in relation to macroeconomic stabilization
(combating high inflation or hyperinflation gradually does not make a lot of sense) but
this argument keeps its rationale when one thinks about radical changes in microeco-
nomic behavior (and this is exactly the case of the post-communist transition).
• Old institutions can damage new policies. This is again a very important argument in
the case of the post-communist transition. In addition, there is a danger of a systemic
vacuum when old institutions and economic mechanisms have already spontaneously
collapsed (as a result of the democratization process) and new ones have not yet
emerged.
• Political economy of the reform process
Table 6.1 summarizes these arguments in relation to the main components of the post-
communist economic transition.
Table 6.1. What can be done gradually?
Can be done If YES, what are the main dangers or negative
Area
gradually? implications?
Macroeconomic stabilization NO
NO; YES - In
Price distortions, inflationary expectations, fiscal
Domestic liberalization exceptional
problems, delayed dem onopolization and privatization
situations
Price distortions, weaker competition, less pressure
External liberalization YES
for restructuring
Delayed restructuring, negative pressure for
Privatization YES macropolicy, intensive rent -seeking, informal
privatization
Delayed restructuring, fiscal crisis, other pressure for
Restructuring of the state
YES macropolicy, intensive rent -seeking, the information
sector (subsidization)
and political barrier in monitoring, credibility problem
Source: Dabrowski (1996).
28 See, among others, Fischer and Gelb (1991); Nuti and Portes (1993); Aslund (1994); Balcerowicz (1994); Balcerowicz and
Gelb (1995); de Melo, Denizer and Gelb (1996); Dabrowski (1996); Aslund, Boone, and Johnson (1996); Stiglitz (1999a, 1999 b);
Dabrowski, Gomulka and Rostowski (2001) and Mau (2000).
81
In further analyses we concentrate on political economy arguments. They are connected

with the observation that the political window of opportunity for carrying out radical reforms
is usually limited in time and should be used to maximum effect. Balcerowicz (1994) devel-
oped the concept of a 'period of extraordinary politics', meaning the special political window
of opportunity just after the collapse of communism when people were ready to accept or
at least tolerate more unpopular and painful reform measures than in 'normal' circumstances.
In addition, various lobbies existing under the old regime become defeated or disorganized
and it takes some time before new influential interest groups emerge. This kind of effect is
also observed in stable democracies and is sometimes referred to as the 'honeymoon effect'
(see Williamson, 1994).
Figure 6.3 illustrates the basic logic of this concept. Its lower part illustrates a radical eco-
nomic strategy, as symbolized by the length of lines S, L and I. Alternative strategies would
have longer lines, or would be shifted to the right, e.g. S shifted to the right would symbol-
ize a delay in stabilization. The upper part of the diagram illustrates the political scene, and
the function r=r (t) expresses the level of readiness to have radical economic measures
accepted, starting at the moment to, which is close to a political breakthrough (i.e. collapse
of communism). However, a high level of r can only be maintained for a relatively short time.
The period of 'extraordinary' politics gives way to 'normal' politics, as described by public
choice theory (e.g. Buchanan, 1993), when r is much lower.
Figure 6.3 also shows two phases of radical economic transformation. Phase 1 is domi-
nated by the effects of those measures which work faster, i.e. S and L, and of faster institu-
tional changes. If all these measures are undertaken shortly after a great political break-
through, then phase 1 largely coincides with the period of extraordinary politics. Phase 2
consists of slower institutional reforms and has to be carried out during the period of 'nor-
Figure 6.3. Political and economic dynamics of the transition process
Period of extraordinary Period of "normal"

politics politics
Politics
r = r (t)
Political capital
Economy
Phase 1P hase 2t ime (t)

t
o
Source: Balcerowicz (1994).
82
mal' politics. However, if phase 1 is successful it can create a 'virtuous' cycle of the next phase
(see previous section). So, the initial speed and consistency of reform also has important
implications for the kind of 'cycle' that will prevail in the further stages of this process. Fast
reform creates less opportunity to capture its intermediate results by 'early' winners.
The experience of the Russian transition has verified positively this hypothesis. Firstly, the
political developments of 1991-1992 demonstrated the limited duration of a period of 'extra-
ordinary' politics. Secondly, indicators presented in Chapter 5 confirm the dangers of a slow
transition listed in Table 6.1. Thirdly, a comparison of Russia's performance with that of CEB
countries (Chapter 5) shows that fast, radical and comprehensive reforms in the economic
and institutional spheres helped to achieve better economic and social results than gradual
and compromise ones29.
Part of the intellectual confusion and misinterpretation of Russia's transition experience
(blaming the so-called 'shock therapy' for unsatisfactory reform outcomes) derives from the
fact that the pace of economic changes in Russia was generally slow (comparing to CEB
countries), in spite of the 'revolutionary' character of the initial program declared at the end
of 1991 by the Gaidar team and its radical rhetoric.
6.6. Hypothesis 6: Democratization helps market reforms
The interrelations between democratization and market reforms has been another hot
topic of theoretical and empirical debate. Generally, empirical research shows at least a par-
tial positive association between democracy and economic reform efforts and outcomes (see
Schmidt-Hebbel, 2003; FH, 2003a). In the case of post-communist countries this interde-
pendence seems to be even much stronger (see e.g. World Bank, 2002; FH, 2001, FH,
2003b; Dabrowski, and Gortat, 2002). It works in both directions, i.e. democracy and the
market economy are mutually reinforcing (EBRD,1999, Box 5.3, p.113). On the one hand,
democracy increases the transparency of government actions, constraints possibilities for
rent-seeking and capturing state institutions and provides opportunities for long-term guar-
antees and stability of property rights (see also the findings presented in Chapter 3). On the
other hand, the market system helps to develop civil society institutions, a broad middle class
and a culture of cooperation based on self-interest, in turn also reinforcing democracy.
The ability of individual countries to start and follow fast and consistent reform strategies
has been determined, to a large extent, by the scale of public support enjoyed by reformers,
29 For deeper empirical evidence related to a wider group of countries see WEO (2000); EBRD (1999); EBRD (2000); World
Bank (2002).
83
which, in turn can be explained by the radicalism of initial political changes (see Chapter 3 on
the importance of the results of the first free election; Aslund, 2002; Dabrowski and Gortat,
2002). If the old communist elite is replaced by the new one convinced of the need to build
a democratic order and market economy (and able to do it) it can give a country a longer
period of 'extraordinary politics' and a chance to exploit this window of opportunity in the
proper way.
In the case of Russia, only partial elite change did took place after the collapse of com-
munism and the disintegration of the USSR. So the process of economic transition was, to a
significant extent, controlled and distorted by the post-communist 'nomenklatura' and newly
emerging 'oligarchs', who were not interested in open society institutions and transparent
market mechanism (they did not represent demand for reforms and new market institutions)
and they tried (successfully to a significant extent) to capture state institutions and use them
for their own benefit. This is well reflected by the social and institutional indicators present-
ed in Chapter 5. Cross-country comparisons of political, institutional and economic variables
(Chapters 3 and 5; Dabrowski and Gortat, 2002) also enable an explanation of Russia's dis-
appointing transition results in terms of a democratic deficit, human rights deficit and civil lib-
erties deficit. Similar conclusion can be drawn from the interregional analysis presented in
Chapter 3. If the recently observed authoritarian drift in Russia (e.g. limiting the role of the
independent mass media) continues it may also in turn seriously damage the prospects of
economic reforms.
84
References
References
Antczak, R. (2003), The Russian Crisis of 1998, [in:] M. Dabrowski (ed.): Currency Crises in
Emerging Markets, Kluwer Academic Publishers, Boston/Dordrecht/London.
Antczak, R., M. Markiewicz, and A. Radziwill (2003), The Failure of the IMF In Preventing
Currency Crises In CIS Countries, [in:] M. Dabrowski (ed.), Currency Crises in Emerging
Markets, Kluwer Academic Publishers, Boston/Dordrecht/London.
Aslund, A. (1994), 'Lessons of the First Four Years of Systemic Change in Eastern Europe',
Journal of Comparative Economics, Vol. 19, No. 1.
Aslund, A. (2002), Building Capitalism: The Transformation of the Former Soviet Bloc,
Cambridge University Press.
Aslund, A., P. Boone, and S. Johnson (1996), 'How to Stabilize: Lessons from Post-commu-
nist Countries', Brookings Papers on Economic Activity, Vol. I, pp. 217-313.
Balcerowicz, L. (1994), 'Understanding Post-communist Transitions', Journal of Democracy,
Vol.5, No.4, October.
Balcerowicz, L. (1995). Socialism, Capitalism, Transformation, CEU Press, Budapest/ New
York.
Balcerowicz, L., and A. Gelb (1995), 'Macropolicies in Transition to a Market Economy: A
Three-Year Perspective', Studies and Analyses, No. 33, CASE Center for Social and
Economic Research.
Beach, W., and G.P. O'Driscoll (2003), Explaining the factors of the Index of Economic Freedom,
[in:] G.P. O'Driscoll, E.J. Feulner E.J., M.A. O'Grady (2003).
Blaszkiewicz, M. and W. Paczynski (2003), The Economic and Social Consequences of Currency
Crises, [in:] M. Dabrowski (ed.), Currency Crises in Emerging Markets, Kluwer Academic
Publishers, Boston/Dordrecht/London.
Booysen, F. (2002), 'An overview and evaluation of composite indices of development', Social
Indicators Research, Vol. 59, pp. 115-151.
Brutskus, B.D. (1922), 'Problemy narodnogo khozyastva pri socyalisticheskom stroe'
(Problems of the national economy under a socialist regime), Ekonomist, No. 1-2.
Buchanan J.M. (1993), 'Public choice after socialism', Public Choice, vol. 77, pp.75-83.
Buiter, W., and I. Szegvari (2002), 'Capital flight and capital outflows from Russia: symptom,
cause and cure', EBRD Working Paper, No. 73, June.
Chubais, A. (1997), 'Sem' glavnykh del pravitels'stva' (The Seven Key Tasks of Government),
Otkrytaya politika, No. 9.
Citrin, D. A. and A. K. Lahiri, (eds) (1995), 'Policy Experiences and Issues in the Baltics,
Russia, and Other Countries of the Former Soviet Union', IMF Occasional Paper, No. 133.
85
Cottarelli, C. and M. I. Blejer (1991), 'Forced Savings and Repressed Inflation in the Soviet
Union: Some Empirical Results, IMF Working Paper, No. 91/55, June.
Dabrowski, M. (1996), 'Different Strategies of Transition to a Market Economy: How do
They Work in Practice?', The World Bank, Policy Research Working Paper, No. 1579,
March.
Dabrowski, M. (1997), The Reasons for the Collapse of the Ruble Zone, [in:] L. T. Orlowski and
D. Salvatore (eds), Trade and Payments in Central and Eastern Europe's Transforming
Economies, Greenwood Press.
Dabrowski, M. (1998), 'Western Aid Conditionality and the Post-Communist Transition',
Journal of Policy Reform 2, pp. 169-193.
Dabrowski, M. (2003), 'Uroki rossiiskogo krizisa: pyat' let spustya' (Lessons from the Russian
Crisis: Five Years On), CASE – Center for Social and Economic Research, Warsaw,
Studies and Analyses, No. 252.
Dabrowski et al. (1993), The Gaidar Programme. Lessons for Poland and Eastern Europe, CASE
& Friedrich Ebert Foundation, Warsaw.
Dabrowski, M., S. Gomulka, and J. Rostowski (2001), 'Whence Reform? A Critique of the
Stiglitz Perspective', The Journal of Economic Policy Reform, Vol. 4, Iss. 4, pp. 291-324.
Dabrowski, M., Paczynski, W., and Rawdanowicz, L. (2002), 'Inflation and Monetary Policy in
Russia: Transition Experience and Future Recommendations', CASE – Center for Social
and Economic Research, Studies & Analyses, No. 241.
Dabrowski, M. and R. Gortat (2002), 'Political Determinants of Economic Reforms in Former
Communist Countries', CASE – Center for Social and Economic Research, Studies and
Analyses, No. 242.
Delyagin, M. (2000), 'Bezotvetstvennost' mezhbyudzhetnoi politiki usilivaet nishchetu i kor-
rupciyu' (Irresponsibility of Inter-governmental Fiscal Relations Gives Rise to Poverty and
Corruption), Finansovaya nedelya, No.1, http://www.dtpress.ru/dd/2000/02/09.htm
De Melo, M., C. Denizer, and A. Gelb (1996), 'From Plan to Market: The Patterns of
Transition', The World Bank, Policy Research Working Paper, No. 1564, January.
Dethier, J-J., H. Ghanem, and E. Zoli (1999), Does Democracy Facilitate the Economic
Transition? An Empirical Study of Central and Eastern Europe and the Former Soviet Union,
mimeo, World Bank, June
Drazen, A. and W. Easterly (2001), 'Do Crises Induce Reform? Simple Empirical Test of
Conventional Wisdom', Economics and Politics, Vol. 13, No. 2, pp. 129-157.
EBRD (1999), Transition Report 1999, European Bank for Reconstruction and Development.
Economist (1996), 'Mr. Yeltsin Flexible Friend', The Economist, Editorial, 13-19 July.
86
References
Fanelli, J.M. and V. Popov (2003), On the Philosophical, Political, and Methodological
Underpinnings of Reform, paper prepared for the Fourth Annual Global Development
Conference 'Globalization and Equity', Workshop on 'Understanding Reform', organized
by the Global Development Network (GDN), Cairo, Egypt, January 15-21,
http://www.gdnet.org/understanding_reform_proposals/PDF/thematic10_draft.pdf
FH (2001), Nations in Transit 2001, Freedom House.
FH (2002), Nations in Transit 2002, Freedom House.
FH (2003a), Freedom in the World 2003, Freedom House.
FH (2003b), Nations in Transit 2003, Freedom House.
Fidrmuc, J. and A. G. Noury (2002), Interest Groups, Stakeholders, and the Distribution of
Benefits and Costs of Reform, paper prepared for the Fourth Annual Global Development
Conference 'Globalization and Equity', Workshop on 'Understanding Reform', organized
by the Global Development Network (GDN), Cairo, Egypt, January 15-21, 2003,
December 2002, http://www.gdnet.org/understanding_reform_proposals/PDF/themat-
ic2_draft.pdf
Fischer, S. and A. Gelb (1991), 'The Process of Socialist Economic Transformation', Journal of
Economic Perspectives, Vol.5, No.4, pp. 91-105.
Gaidar, Ye. (1995), Gosudarstvo i evolyutsya (State and Evolution), Evraziya, Moscow.
Gaidar, Ye. (1997), Anomalii ekonomicheskogo rosta (Anomalies of economic growth),
Evraziya, Moscow.
Gaidar, Ye. (1999), Days of Defeat and Victory, University of Washington Press, Seattle, WA.
Gaidar, Ye. (2003a), Vosstanovitelnyi rost i nekotorye osobennosti sovremennoi ekonomicheskoi
situatsii v Rossii (Economic Recovery and Some Peculiarities of the Current Economic
Situation in Russia), March 25, (http://www.iet.ru/personal/gaidar/vostrost.htm)
Gaidar, Ye. (2003b): On modern economic growth and catch-up development, IET, April 17,
http://www.iet.ru/personal/ gaidar/26feb2003en.htm
Gaidar, Ye., et al. (1998), Ekonomika perekhodnogo perioda. Ocherki ekonomicheskoi politiki
postkommunisticheskoi Rossii (1991-1997) [Economics of Transition. Studies on Economic
Policy of Postcommunist Russia], IET, Moscow.
Gaidar, Ye., et al. (2003), The Economics of Russian Transition, MIT Press
Gambaryan, M. and V. Mau (1997), 'Ekonomika i vybory: opyt kolichestvennogo analiza' (The
Economy and Election: Experience of Quantitative Analysis), Voprosy Ekonomiki, No. 4.
GAO (2000), Foreign Assistance. International Efforts to aid Russia's Transition Have Had Mixed
Results, US General Accounting Office, November.
Gelb, A., A. L. Hillman, and H. W. Ursprung (1995), Rents and Transition, background paper
prepared for the World Development Report 1996, World Bank, August 15.
Golant O., S. Zhavoronkov, V. Mau, D. Chernyi, and K. Yanovskiy (2001), 'Problemy
stanovleniya novoi institucional'noi struktury w perekhodnykh stranakh' (Problems of emer-
87
gence of a new institutional structure in transitional nations), IET Working Papers, No. 31.
Gomulka, S. (1995), 'The IMF-supported programs of Poland and Russia, 1990-1994: princi-
ples, errors and results', CASE – Center for Social and Economic Research, Warsaw,
Studies and Analyses, No. 36.
Grachev, A. (2001), Gorbachev, Vagrius, Moscow.
Gwartney, J. and R. Lawson (2003), Economic Freedom of the World: 2003 Annual Report, The
Fraser Institute, Vancouver, http://www.freetheworld.com/release.html
HDR (2003), Human Development Report 2003: Millennium Development Goals. A Compact
among Nations to End Human Poverty, the United Nations Development Program, Oxford
University Press, New York & Oxford.
Hellman, J. (1998), 'Winners Take All: the Politics of Partial Reform', World Politics, Vol. 50,
pp. 203-234.
Huntington, S.P. (1991), Political Order in Changing Societies, Yale University Press, New
Haven.
IET (2003), 'Russian Economy in 2002', Trends and Outlooks, Issue No. 24, Institute for the
Economy in Transition, Moscow, April.
IMF (1992), Economic Review. The Russian Federation, IMF, Washington, D.C., April
IMF (2000), 'Transition Economies: An IMF Perspective on Progress and Prospects', IMF
Issues Brief, November 3.
Johnson, S., D. Kaufmann, and A. Shleifer (1997), 'The Unofficial Economy in Transition',
Brookings Papers on Economic Activity, Vol. 27, No. 2, pp. 159-239.
Kapur, I. and E. ven der Mensbrugghe (1997), 'External Borrowing by the Baltics and Other
Countries of the Former Soviet Union: Developments and Policy Issues', IMF Working
Paper, 97/72.
Kirton, J., E. Kokotsis, and M.M. Malleson (2003), G7/8 Summit Commitments, 1975-2002.
Complete Data Set, March 27, http://www.g7.utoronto.ca/datasets/allcommitments/
Klaus, V. (1997), Renaissance. The Rebirth of Liberty in the Hearth of Europe, CATO Institute,
Washington, D.C.
Krueger, A.O. (1993), Political Economy of Policy Reform in Developing Countries (The Ohlin
Lectures), The MIT Press.
Kryuchkova, P.V. (2001), Administrativnye bar'ery v rossiyskoi ekonomike (Administrative Barriers
in the Russian Economy), Institute for National Public Compact Project, Moscow.
Loungani, P. and P. Mauro (2000), 'Capital Flight from Russia', IMF Policy Discussion Paper, No.
00/06, June.
Maleva, T. (2002), Social Consequences of Reform, paper prepared for the Fourth Annual
Global Development Conference 'Globalization and Equity', Workshop on
'Understanding Reform', organized by the Global Development Network (GDN), Cairo,
Egypt, January 15-21, 2003.
88
References
Mau, V. (1996), The Political History of Economic Reform in Russia, 1985-1994, Centre for
Research into Communist Economies, London, U.K.
Mau, V. (2000), Russian Economic Reforms as Seen by an Insider: Success or Failure?, Royal
Institute of International Affairs, London, U.K.
Mau, V. and I. Starodubrovskaya (2001), The Challenge of Revolution. Contemporary Russia in
Historical Perspective, Oxford University Press, Oxford, U.K.
Mau, V., K. Yanovskiy, S. Zhavoronkov, and D. Chernyi (2001), Rezultaty vyborov, kak pokaza-
tel sprosa na instituty na primere golosovaniy v techeniye pervogo poslerevolutsionnogo desy-
atiletiya v stranakh s perekhodnoi ekonomikoi i molodoi demokratii (Election results as an
indicator of demand for institutions: voting results in transition economies and new
democracies over the first post-revolutionary decade), IET, Moscow.
Mau, V. and K. Yanovskiy (2002a), 'Political and Legal Factors of Economic Growth in Russian
Regions', Post-Communist Economies, Vol. 14, No. 3, 2002.
Mau V., S. Zhavoronkov, O. Fomitchev, K.Yanovskiy, P. Hobson, and L. Lederman (2002b),
Investment Risks in Russia's Regions: Political and Legal Origins, IET-CEPRA, Moscow.
Mau V., S. Zhavoronkov, O. Fomichev, A. Shadrin, and K. Yanovskiy (2003a),
'Deregulirovanie rossiiskoi ekonomiki: mekhanizm vosproizvodstva izbytochnogo reg-
ulirovaniya i institucional'naya podderzhka konkurencii na tovarnykh rynkakh'
(Deregulation of the Russian economy: the mechanism of reproduction of the excessive
regulation and institutional support of competition on commodity markets), IET Working
Papers, No. 48.
Mau V., S. Zhavoronkov, A. Shadrin, K. Yanovsky et. al. (2003b), Importirovannye instituty v
stranah s perehodnoi ekonomikoi: effektivnost' i izderzhki (Imported Institutions in Transition
Countries: Efficiency and Costs), IET, Moscow.
Mises, L. v. (1981), Socialism: An Economic and Sociological Analysis, Liberty Classic, Indianapolis.
Nordhaus W. (1975), 'The Political Business Cycle', Review of Economic Studies, vol. 42, April.
Nuti, D. M., and R. Portes (1993), Central Europe: the way forward, [w:] R.Portes (ed.):
Economic Transformation in Central Europe. A Progress Report, CEPR and European
Communities.
Odling-Smee, J. and B. Zavoico (1998), 'External Borrowing in the Baltics, Russia, and Other
States of the Former Soviet Union – the Transition to a Market Economy', IMF Papers on
Policy Analysis and Assessments, No. 98/5, May.
Odling-Smee, J. and G. Pastor (2001), 'The IMF and the Ruble Area, 1991-93', IMF Working
Paper, 01/101, August.
O'Driscoll, G.P., E.J. Feulner, and M.A. O'Grady (2003), 2003 Index of Economic Freedom, The
Heritage Foundation & The Wall Street Journal.
Ofer, Gur (1987), 'Soviet Economic Growth: 1928-85', Journal of Economic Literature, Vol.
XXV, pp. 1767-1833.
89
OED (2002), Assisting Russia's Transition. An Unprecedented Challenge, World Bank Operation
Evaluation Department, Washington, D.C., http://www.worldbank.org/oed/russia_cae/
Olson, M. (1994), 'The Logic of Collective Action. Public Goods and The Theory of Groups',,
Harvard Economic Studies, No. 124, fifteenth printing, Harvard University Press.
Olson, M. (2000), Power and Prosperity, New York, Basic Books.
Popov, V. (2001), Fiscal Federalism in Russia: Rules versus Electoral Politics, http://www.nes.ru/
public-presentations/Papers/Popov.htm
Rostowski, Jacek (2001), Background Paper on World Bank Group Assistance to Russia.
Economic and Public Sector Management, January 23.
Ruis, A., and N. van de Valle (2003), Political and Cultural Institutions and Economic Policy
Reform, paper prepared for the Fourth Annual Global Development Conference
'Globalization and Equity', Workshop on 'Understanding Reform', organized by the Global
Development Network (GDN), Cairo, Egypt, January 15-21, 2003,
http://www.gdnet.org/understanding_reform_proposals/PDF/thematic3_draft.pdf
Sachs, Jeffrey D. (1994a), 'Russia: IMF gives too little, too late', Financial Times, March 31.
Sachs, Jeffrey D. (1994b), Russia's Struggle with Stabilization: Conceptual Issues and Evidence,
Proceedings of the World Bank Annual Conference on Development Economics, pp. 57-
80.
Schmidt-Hebbel, K. (2003), Panel on Final Terms of Reference GDN Workshop on
'Understanding Reform' Project, Cairo (Egypt), January 17.
Snelbecker, D. (1995), 'The Political Economy of Privatization in Ukraine', CASE – Center for
Social and Economic Research, Warsaw, Studies and Analyses, No. 59.
Solow, R. M. (1956), 'Contribution to the Theory of Economic Growth', Quarterly Journal of
Economics, pp. 65-94.
Stiglitz, J. (1999a), Whither Reform?, paper for 1999 ABCDE Conference, Washington DC:
World Bank. http://www.worldbank.org/knowledge/chiefecon
Stiglitz, J. (1999b), 'Quis Custodiet Ipsos Custodes? (Who is to Guard the Guardians them-
selves?)', Challenge, 42 (6), November/December, pp. 26-67.
Stiglitz, J. and D. Ellerman (2000), 'New Bridges Across the Chasm: Macro- and Micro-
Strategies for Russia and other Transitional Economies', Zagreb International Review of
Economics & Business, Vol. 3 (1), pp. 41-72.
WEO (2000), World Economic Outlook, Advance Copy, International Monetary Fund,
September.
WEO (2001), World Economic Outlook, Advance Copy, International Monetary Fund, April
Williamson, J. (ed.) (1994), The Political Economy of Policy Reform, Institute for International
Economics, Washington, DC.
World Bank (2000a), Anticorruption in Transition: A Contribution to the Policy Debate, World
Bank, Washington, D.C.
90
References
World Bank (2000b), Making Transition Work for Everyone: Poverty and inequality in Europe and
Central Asia, World Bank, Washington, D.C.
World Bank (2002), Transition. The First Ten Years. Analysis and Lessons for Eastern Europe and
the Former Soviet Union, World Bank
World Bank (2003), Global Economic Prospects 2004, World Bank, Washington, D.C.
Yanovskiy, K. (2001), Politicheskaya ekonomiya privatizacii (mechanizm prinyatiya reshenii)
[Political Economy of Privatization (Mechanisms of Decision-making)], Moscow, ILPP,
http://www.ilpp.ru/projects/govern/yanovsky/yanovsky_1.html
Yanovskiy, K., S. Zhavoronkov, O. Kochetkova, A. Mazhuga, D. Chernyi, P-M. Dejardin, P.
Hobson, and D. Savoie (2001), Politico-Economic Problems of the Russian Regions, Moscow, IET.
Yasin, Ye. (2003), Rossiiskaya ekonomika. Istoki i panorama rynochnykh reform (Russian
Economy. Origins and Outlook of Market Reforms), Moscow, HSE.
Yasin, Ye. (2002), 'Bremya gosudarstva i ekonomicheskaya politika: liberal'naya al'ternativa'
(The Burden of the State and Economic Policy: The Liberal Alternative), Voprosy
Ekonomiki, No. 11.
Zanini, G. et al. (2002), Assisting Russia's Transition. An Unprecedented Challenge, World Bank,
Operation Evaluation Department, Washington, D.C.
Zhavoronkov, S. (2001), Politicheskaya ekonomiya finansovogo krizisa (Political Economy of
Financial Crisis), Moscow, ILPP, http://www.ilpp.ru/projects/govern/zhavoronkov/zha-
voron_1.html
Zhavoronkov, S. and K. Yanovskiy (2001), Politicheskaya ekonomiya reformy: mekhanizm priny-
atiya reshenii na etapakh revolyucii i stabilizacii (Political Economy of the Reforms: the
Decision-making Mechanism in the Phases of Revolution and Stabilization), Moscow, ILPP,
http://www.ilpp.ru/projects/govern/zhav_yan/zhav_yan0.html
91

Russia: Political and Institutional Determinants of Economic Reforms

Uploaded by

Copyright:

Available Formats

You might also like

Russia: Political and Institutional Determinants of Economic Reforms

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Russia: Political and Institutional Determinants of Economic Reforms

Uploaded by

Copyright:

Available Formats

Center for Social and Economic Research

Russia: Political and

Marek Dabrowski, ed. (CASE)

Sergei Zhavoronkov (IET)

Moscow – Warsaw, March 2004

Electronic copy available at: http://ssrn.com/abstract=1431892

Review by José María Fanelli, PhD

© CASE – Center for Social and Economic Research, Warsaw 2004

Graphic Design: Agnieszka Natalia Bury

DTP: CeDeWu Sp. z o.o.

ISSN 1506-1647, ISBN: 83-7178-336-1

Electronic copy available at: http://ssrn.com/abstract=1431892

List of Tables and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

2. History of the Soviet/Russian political and economic reforms 1985-2002 . . 14

3. Political economy of reform – an attempt at a quantitative analysis . . . . . . 32

Electronic copy available at: http://ssrn.com/abstract=1431892

4. External leveraging of Russia's reforms: the role of the IMF,

5. The Effects of Economic Reform in Russia . . . . . . . . . . . . . . . . . . . . . . . . . . 53

6. Main Hypotheses and Results of Their Testing . . . . . . . . . . . . . . . . . . . . . . . 71

Table 2.1: Spot crude oil prices, 1972-1998, USD/bbl . . . . . . . . . . . . . . . . . . . . . . . . . 15

Figure 2.1: General Government Budget Balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

1For details concerning the 'Understanding Reforms" project see

2.2. The destabilizing effects of the 'Perestroika' period 1985-1991

2.3. 'Revolutionary' period of reforms, end of 1991-1994

of Dabrowski, Gomulka, and Rostowski [2001].

2.4. The fragile and illusory stabilization of 1995-1998

2.5. Post-crisis period (1999-2003)

2.6. The overall record and list of unresolved problems

2. History of the Soviet/Russian political and economic reforms 1985-2002

2. History of the Soviet/Russian political and economic reforms 1985-2002

Appendix 2.2. Main institutional changes in Russia, 1985-2003

The Gorbachev period, 1985-1991

Period of 'revolutionary' reforms, 1991-1994

The period of fragile and illusory stabilization, 1994 -1998

• Draft law "On the licensing of certain activities", September 1998)

The post-crisis period, 1999-2003

Appendix 2.3: Professional and political debate on economic

3.1. The importance of election statistics

3.2. The basic model

s = s (Rpolitical, Rlegal, …); y = y (s, …) (3.1)

3.3. The International Analysis

Table 3.2. Summary Data on Regressions from the Principal Components

3.4. The Interregional Analysis

3.4.1. The significance of the pro-reform coalition

Table 3.3. Interregional model: Summary Data on Simple Linear Regressions

3.5. Buying votes and pro-reform coalitions

evidence supporting their point of view.

3.6. Some conclusions

The preceding analysis allows us to draw the following conclusions:

4.1. The overall picture

4.2. Some motivation of lending to Russia

4.3. The role of the IMF

Figure 4.2. IMF net disbursements to Russia in 1992-2001 (millions of USD)

4.4. The role of the World Bank

4.5. The role of the G7

5.1. Macroeconomic developments

Figure 5.1. GDP (constant 1995 USD), annual % change

instead was determined by a centralized state planning system, primarily in military-industri-

Source: Central Bank of Russia www.cbr.ru;